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EarningCall_1400
Greetings, and welcome to Ark Restaurants' Fourth Quarter and Year End 2022 Results 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]. As a reminder, this conference is being recorded. Thank you, operator. Good morning and thank you for joining us on our conference call for the fourth quarter and year ended October 1, 2022. My name is Christopher Love, and I’m the Secretary of Ark Restaurants. With me on the call today is Michael Weinstein, our Chairman and CEO; Anthony Sirica, our President and Chief Financial Officer; and Vinny Pascal, our Chief Operating Officer. For those of you who have not yet obtained a copy of our press release, it was issued over the newswires yesterday and is available on our Web site. To review the full text of that press release, along with the associated financial tables, please go to our homepage at www.arkrestaurants.com. Before we begin, however, I'd like to read the Safe Harbor statement. I need to remind everyone that part of our discussion this morning will include forward-looking statements and that these statements are not guarantees of future performance, and therefore, undue reliance should not be placed on them. We refer everyone to our filings with the Securities and Exchange Commission for a more detailed discussion of the risks that may have direct bearing on our operating results, performance and financial condition. Hi, everybody. Thank you for joining us today. The comparisons of the September quarter this year with the September quarter last year are affected by two segments of our expense side. One is a substantial increase in payrolls and the other is a substantial increase in occupancy costs. In order to try to get the flow of the business directly stated of where we are, I want to first have Anthony explain occupancy costs and how the September quarter this year compares to the September quarter last year, what were the big differences, because there were adjustments last year which sort of inflated EBITDA in the fourth quarter and there are adjustments this year which sort of deflate our EBITDA in the current September quarter. So, Anthony. So last year, we had adjustments related to the finalization of some COVID abatement deals that were recorded in the fourth quarter. So what happened was, there were several landlords where we were negotiating, still negotiating COVID rent abatements in 2021. So we were still accruing the normal base rents the whole time, because even according to the accounting standards, we couldn't record any abatements until we had signed deals. Those deals were signed last year in the fourth quarter and they will recorded, which reduced occupancy last year by about $800 to $1 million. In the current year, we also had some adjustments to occupancy costs related to the Vegas leases finalized in July and August for percentage rents that need to be accrued back to the beginning of the year based on the final deals. So all-in-all, you're probably looking at $2 million swing between those two items. And that's why occupancy looks so odd. So basically, last year we reversed an accrual of rents for the full year of our fiscal year 2021 in September, which created $1 million increase in EBITDA essentially based upon that accrual. This year, the opposite happened. Because we didn't have signed leases in Vegas, we weren't allowed to approve for the full year as the year was going on until the leases were signed and essentially those rents for the full year, because we had to go back to January 1 of 2022 where about $1 million that fell into the fourth quarter. So there's a $2 million swing here. I'd like to address payroll costs. That's the other big item. Payroll went up roughly $2.8 million compared to last year, September quarter. What's interesting is the payrolls now as a percentage of sales mirror what was our pre-pandemic percentages on sales in the same quarter before the pandemic and year end. So we're back to essentially full employment. I may have made a mistake. As laborers started to loosen up, my directive to all my managers was that because we couldn't find good people, we were having trouble finding good people for these restaurants. We were having a lot of turnover. We would hire people. They would leave after three, four or five weeks. It was a mess. And as the market opened up a little bit, especially in Vegas, and I want to talk about that a little bit more, the directive was just find the right people. And if we have to pay them more which we're going to have to pay them more, just get them on board. That stood us very well in 2008, 2009 when things got very rough for us. We said that our customers were going to have a tough time spending money in restaurants when the economy was really tanking. And the last thing they want to do is if they spend money in a restaurant is see bad service because we don't have enough people to service them. So basically, we don't want to be in that position going forward. And markets started to ease up with good people to fill these jobs that had been vacant or jobs where we didn't have the right people [indiscernible] and we're paying more. But in the end, we're back to pre-pandemic levels. So the September quarter essentially, our sales increased $4 million. We had this $2 million swing from the September quarter last year in rents and we had a $2.8 million swing in labor costs. So that sort of will get you to where the main differences were and how they occurred. In terms of our business, the September quarter, we were not raising prices aggressively at all. And in many of the restaurants, we just stopped. We don't know -- it's an art form to try to figure out what the elasticity of pricing could be in some of these restaurants, but we're at prices that are sort of special when you've been in business 50 years. It’s sort of unfathomable to me even though they may be rationalized by the costs, it doesn't mean that the customers are going to look at them and feel comfortable paying them. This is especially acute in Rustic Inn in Florida. We're now serving a two pound order of king crabs. I always go back to this as an example. It cost us 85% of the sales price to put that dish out. We're charging $135 for it. It used to be a $75 dish. I would tell you one out of four people who go to the Rustic Inn go there for that dish. It used to be a 50% food cost, but a high dollar profit. Now it's an 85% food cost and the fact of the matter is, even though we’re almost definite it will pay, our customers can't afford it. They are now sharing it. People are not coming as frequently for it. We have a blue collar crowd there. And it just becomes a celebratory when people have anniversaries of birthdays. But we're losing headcounts there. Our business in the September quarter was down some 20% plus in Rustic and that sort of had a big impact on our EBITDA as well. That's an extraordinarily profitable restaurant. The rest of Florida, we're doing fine. Our Food Courts and the two Hard Rocks performed well. JB’s, Blue Moon, Shuckers, all performed well. Alabama performed very well. Las Vegas performed very well. New York is performing well because of significantly increased events and price increases that we put through to people having events which have been readily accepted. There seems to be a big pent-up demand for events in New York and Washington DC. So the business is fine. We did $4 million, as I said, an increase in sales. The two big items which need to be understood as to why the comparison looks significantly different between last September and this September's quarter are rents and those reversals of accruals last year and the increased accruals this year and labor. I think we're in very good shape with labor now. I think we're going to get more efficient with labor as we hire better people. I think the headcounts of the number of employees we have will sort of go down, because in many cases we had two people doing the job or one person. We had a lot of overtime. That's going to start to be eliminated. So I think we're going to become more efficient. Thank you. Ladies and gentlemen, at this time, we will be conducting a question-and-answer session. [Operator Instructions]. Our first question comes from the line of Paul Johnson [ph], a private investor. Please proceed with your question. Good morning and thank you for the explanation around those numbers. So I guess the tricky thing is to try to predict what is sort of a normal level of payroll and occupancy costs? And so I’m wondering, I know you don't give forward guidance, but all things being equal going forward for, let's say, the next fiscal year, do you think that we should be using this level of EBITDA, let's say, going forward, again, obviously not predicting what can happen to the economy and traffic and all that, but all things being equal, would you say that the payroll and occupancy costs incurred over the last fiscal year are what we should be modeling going forward? It's a tough question. I can't -- I think there's one thing that we all have to be aware of. Our business in Vegas has been extremely well. We have new management in place in Vegas. They were not left -- the new management was not left with the best of circumstances. There were holes that we could not fill. Last year in Vegas two new hotels came on board. They required 8,000 people in the labor market. That was impossible to start out with. What covered up our struggles and helped us dramatically was this boom and acceptance of higher prices in Vegas when we did put through price increases. My one concern is, is that level of sales sustainable. There's a lot of reasons to think it is. Conventions are coming back. The T-Mobile Arena, which is right next to New York-New York where most of our sales in Vegas come from, is more active than ever between hockey games and concerts. There's a football team there now. There's NBA teams scheduled to come in. So we think the sales should continue with these levels. But I must say between price increases and EBIT, customer accounts, our Vegas business was up 15% from the year before. As long as that's sustainable, I think the level of earnings that we had for the year, this year, are probably sustainable. I honestly expect New York to continue to perform well. Sequoia in Washington should perform better. I don't see any reason for Florida to do anything but continue to do its current levels of volumes. And there's a big hole missing in Rustic’s EBITDA. That restaurant used to be $3.4 million in operating cash flow, it's down to $1.6 million annualized. So the $14 million number of EBITDA that we did this year, that's a big hole. $1.8 million is missing from Rustic Inn. So I think that should do hopefully better at some point, maybe not immediately. The Vegas numbers had a one-time $500,000 retirement payment for Paul Gordon who retired as General Manager. So there's some -- that's a true one-time expense item that Anthony could speak with. We're paying down the term loan with our bank. Maybe Anthony should speak to the balance sheet for a second. But we're paying down a term loan and exchanging that for a credit line for the same amount. That will save us $400,000 of interest charges. Right now, Anthony, if I'm correct, we have about $28 million, $29 million in cash in the bank. What's the debt? 23 million in long-term debt, plus $5 million there. We're in a strong position to make acquisitions. I actually see the $14 million number as a base, if that's an answer as opposed to being at risk, I see that as the base and hopefully we can get beyond that. Yes, I’ll be happy to. It's a repeat of the last update. We definitely think the Meadowlands will be the site for a casino in northern New Jersey for a variety of reasons. Number one, the Racetrack already has betting going on, and that's an advantage. The sports betting at the Meadowlands I think has been the largest single U.S. site for sports betting. Although there's been an encroachment with online betting in New York, we’re still doing very well there. The drop off has not been as significantly affected as we would have thought. The whole thing is permitted for environmental and other sites would have to go through. We're not in a neighborhood that we would get residential lawsuits. So we think if New Jersey wants to start to get tax money from the operation of casino where we would literally be 90 days away if it was approved from having a casino operation literally. The Racetrack was designed with that in mind. The whole theory about getting this passed by the citizens of New Jersey, because they had to change the constitution essentially referendum would be to have New York casinos operating downstate, which means Yonkers, Long Island, and perhaps even Manhattan. There are two groups vying for one of the three licenses in Manhattan. If those licenses are issued or if they start building and operating, certainly Yonkers and Aqueduct could operate right away. And New Jersey recognizes that there is a flow from New Jersey to those New York casinos. We think that's the time ideally to get this referendum passed. So that's the plan. Murphy is very -- the governor in New Jersey is very favorable. He has said that to having a northern casino. The only thing we don't know is what that referendum would look like. Last time the referendum required that the casino be operated by some company that is already licensed in New Jersey, which will be one of the Atlantic City operators. At that time when the first referendum which was not going to pass, Hard Rock did not have a casino in New Jersey. They now do. They run the old Taj Mahal and there are our partners in this venture. So I think nothing negative has happened. And positive circumstances are that we still do a lot of sports betting onsite and the New York casinos are moving forward. So I think that all plays well into our hopes of getting a casino license. Thank you. And just finally on that, I know you've mentioned in the past that the logical conclusion would be for someone like Hard Rock to buy us out. Some people have speculated that the value that they would -- at the price they'd have to pay is almost equal to the whole market cap of Ark. Is that within the realm of possibility from your point of view? I won't accept a number equal to the capitalization. I think it's worth much more. Look, when we -- I'm not speaking out of school here. When we were looking for partners when it looked like the first referendum was going to come to fruition, which it did and it was voted down because it was badly written, it sounded like the state had to put up the money, which was not true. There was no mention in the referendum of where the tax money was going to be allocated to, whether nursing homes or education, it was just fluff. But we did have a conversation with MGM because even though Hard Rock was our 20% partner in the deal, we needed a licensed operator in Jersey to operate in the North. And MGM gave us projections that this thing would do $500 million a year after paying taxes and cash flow. So we own 7%, almost 8% of this thing fully diluted. There will be more dilution if we can come up with our percentage of equity. So even if we own 4%, that's $20 million of cash flow that you could attribute to Ark’s interest. We also have an exclusive on all the food and beverage with the exception of a carve out for a Hard Rock Cafe. That's probably a $50 million, $60 million business for us. So the potential economics are extraordinary. But first, get casino license. We don't have that. I don't know what that's worth. But certainly, I don't think it’s priced into the stock. [Operator Instructions]. Our next question comes from the line of Jason Walters [ph], a private investor. Please proceed with your question. Thanks. Good morning, guys. A quick question on acquisitions and capital allocation. I know, Michael, you like to purchase companies for 3x to 5x EBITDA depending on whether you're getting the land included and Ark is trading at that level or below that level. Any thoughts on share repurchases, a? And then, b, what are you seeing in terms of opportunities from the acquisition side? Thank you. Well, thank you. And I'm glad you got it right, the 3x to 5x depending upon whether land comes with it or not is absolutely correct. So we're constantly looking. We've seen a couple of interesting things. There are ongoing discussions, one of them further along than the other. The philosophy here would be we would rather acquire cash flow, which would be hopefully long-term consistent cash flow than reducing the number of shares. We think we're better off acquiring assets as opposed to share repurchase. And another influence, which we don't even think about but you should think about is already the liquidity built into our capitalization. We just don't have that many shares outstanding, floating around. I could tell you where 60% or 65% of the float is right now and it's not leaving those hands. So we just don't have enough shares outstanding. That's a bad thing because somebody that wants to buy it has to find moments like this when the stock is down and maybe there's a seller. But also it's a bad thing if you want to sell the stock. A block comes up, there's not necessarily a buyer available. So we just don't want to shrink the shares anymore. That all being said, we’re still much better off buying stuff at 3x to 5x with lease positions where we have 25 years left on a lease, if it's a lease; or if we own the land, it’s forever. We're confident enough that we know how to run these things. The cash flow from an acquisition should be long lasting. We've been very lucky in the past. And make no mistake, I think we made smart acquisitions, but the luck involved has been that every chef and every manager of every restaurant that we've acquired has stayed with us. It's extraordinary. I think we're a good company to work for. But to have nobody leave and have all that expertise, I'm not so sure we'll be as fortunate going forward. I hope so. But that's a big issue with us as well and slows us down in jumping into acquisitions. We got to make sure that we have management in place that we have a good chance of retaining. So I hope that answers your question. Thank you. We're working hard here. We really are. Hopefully, things continue to improve for us. And we'll speak to you in the next quarter. And I appreciate your participation and the questions, very good today and gives me a chance to explain the business a little bit better. Have a good day. Happy holidays, everybody. Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.
EarningCall_1401
Good morning, and welcome to the Liberty Energy 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. Thank you, Gary. Good morning, and welcome to the Liberty Energy fourth quarter and full year 2022 earnings conference call. Joining us on the call are Chris Wright, Chief Executive Officer; Ron Gusek, President; and Michael Stock, Chief Financial Officer. Before we begin, I would like to remind all participants that some of our comments today may include forward-looking statements reflecting the company's view about future prospects, revenues, expenses or profits. These matters involve risks and uncertainties that could cause actual results to differ materially from our forward-looking statements. These statements reflect the company's beliefs based on current conditions that are subject to certain risks and uncertainties that are detailed in our earnings release and other public filings. Our comments today also include non-GAAP financial and operational measures. These non-GAAP measures, including EBITDA, adjusted EBITDA, adjusted pretax return on capital employed and cash return on capital invested are not a substitute for GAAP measures and may not be comparable to similar measures of other companies. A reconciliation of net income to EBITDA and adjusted EBITDA and the calculation of adjusted pretax return on capital employed and cash return on capital invested as discussed on this call, are presented in the company's earnings release, which is available on the Investors Section of its website. Good morning, everyone, and thank you for joining us for our fourth quarter and full year 2022 operational and financial results. Liberty achieved outstanding returns in 2022, with the highest earnings per share in company history. Full year adjusted pretax return on capital employed, ROCE and cash return on capital invested, CROCI, were each at 31% and both accelerated as the year progressed. These results demonstrate the enhanced earnings power of our diversified platform and technology portfolio as well as our profitability potential over the longer duration cycle ahead. 2022 revenue grew to $4.1 billion, a 68% increase over the prior year. Net income was $400 million or $2.11 fully diluted earnings per share. Adjusted EBITDA increased to $860 million. Fourth quarter revenue of $1.2 billion increased 3% sequentially, and adjusted EBITDA grew 7% sequentially to $295 million as continued momentum from strong execution in the third quarter and strengthening pricing more than offset weather and holiday seasonality. Michael will review our financial results in greater depth. But suffice it to say, we are pleased with the tremendous improvement we saw in each successive quarter throughout 2022. Our strong conviction in the outlook and growing free cash flow led us to launch and expand a sector-leading return of capital strategy in 2022. We paid our first quarterly cash dividend since the pandemic during the fourth quarter and earlier this week, we upsized our July 2022 share repurchase program from $250 million to $500 million. In the second half of 2022, we returned a combined $134 million in share repurchases and dividend payments to shareholders. We retired 4.4% of our outstanding shares since last July, and we now have $375 million remaining in our authorization. We are focused on the opportunistic execution of our buyback strategy and the speed at which we execute on our buyback authorization will be driven by the relative dislocation in our stock price relative to what we believe the intrinsic value of the stock to be. Our 2022 financial performance illustrated the value created from our actions over the pandemic years, including transformative transactions, technology innovation and investment in the extraordinary talent at Liberty for future success. Together, the Liberty team achieved new records whether measured by revenue, pump hours per fleet, frac stages or tons of sand pumped, all of which were delivered while navigating tight supply and labor markets. We always strive to raise the bar of elite service quality and performance in the industry. Today, dependability and efficiency are critical to our customers who contend with meeting development plans in a tight frac market and volatile commodity price environment. The frac market is currently tight in all shale basins. In any given year, the near-term fundamental picture can ebb and flow. And today, natural gas markets are in focus, an increase in natural gas storage levels from a rise in domestic production, moderate winter weather so far and lower LNG export growth are weighing on gas prices. To-date, there has not been any significant reduction in activity in the natural gas regions despite a significant drop in gas prices. We do expect to see some industry pullback in response to gas prices. And if necessary, Liberty would move any spare capacity to oilier areas where demand for our services significantly outstrips our current supply. This issue is not a significant concern for Liberty. While markets are preparing for the most widely anticipated recession in nearly 50 years, tumult in global oil supply, coupled with today's rather low spare global production capacity implies strong need for North American barrels in the coming years. Today's low spare production capacity is the inevitable result from years of underinvestment in upstream oil and gas production. The gradual reopening of China and rising global travel are expected to drive incremental demand for oil, even it balanced against slowing economic activity. Oil supply, on the other hand, growth remains very challenged as the release of U.S. strategic petroleum reserves subsides. The impact of the Russian oil products export embargo hits next month and reduced investment across the Russian industry gradually impacts production. The fundamental outlook for North American hydrocarbons is the healthiest Liberty has seen in our 12-year history. Against this strong backdrop, we expect many possible bumps in the road like softening in natural gas activity and elevated recession risk. However, the multiyear outlook for North American activity is robust. Currently, our customers and competitors are investing with discipline, keeping capacity flat to only very modest growth. For years, E&P operators, oil and gas alike have invested in expanding metal inventory, understanding the geology and resource quality, optimizing drilling and completion designs and assembling their teams to execute on development plans. Their hard work is now paying off with high rates of return, particularly in oil, even as breakeven prices have increased from extreme pandemic lows. The majors are redirecting capital spending to the attractive risk reward opportunities in North America. Independents continue their robust shale programs at a minimum to offset natural production declines. As North American oil and gas portion reaches new heights. There is a rising level of frac activity simply required to keep our customers' production flat. Two factors summarized today's frac market, full utilization of existing frac capacity and strong demand for gas-powered fleets that significantly reduced fuel costs natural gas is much cheaper than diesel, while driving down frac fleet emissions. This transition to natural gas-powered fleets is happening at a measured pace, roughly aligned with the attrition of the industry's older generation diesel frac capacity. There is also a wide variety of performance specs, quality of these next-generation fleets, and we are investing to be the technical leader. When the shale revolution expanded to include oil basins as well as gas basins, roughly a dozen years ago, there was a building frenzy of new frac fleets, the overhang of these excess fleets took many years to overcome. Today, that overhang is gone, and all the large players in frac are investing with discipline. Today, frac fleet demand sufficient to keep production roughly flat or drive only very modest growth requires all existing frac capacity. Tighter labor markets and supply chain challenges are making it hard for the smaller players and lower quality players to keep their existing fleets running and deliver an acceptable quality of service. Aging frac pumps and limitations to maintenance supply chains promote the attrition of older equipment across the completion market. Equipment are treated in recent years has largely been scrapped or sold for industrial applications in international markets, and we see these trends continuing for the foreseeable future as gas-powered technologies take hold. Hence, we view the risk of surging frac fleet capacity supply crashing service prices as relatively low. Of course, we closely monitor frac market conditions and would adjust our behavior if clouds appear on the horizon. Today's tight frac market creates a sense of urgency among E&P operators to align with top-tier partners for both differential long-term technology and the outstanding service quality required to deliver on their production goals. Over the past few years, Liberty's team has rapidly innovated to develop the most technically advantaged frac fleet with digiFrac and 2022 marks the first commercial deployment of these game-changing pumps. digiFrac sets the bar for combining the lowest emission fleets in the market with superior design, of performance, reliability and cost efficiency. We are currently undergoing a phased deployment of our first fleet as the modularity of both our pumps and high thermal efficiency power production allows us to commission the fleet on a pump-by-pump basis while maintaining continuity of operations for our customers. digiFrac pumps are fully compatible with our existing conventional and dual fuel pumps as they all share our proprietary control software, allowing optimization of pump operations across the fleet. Gas-powered pumps are a focus of our innovation efforts as we look to develop technologies that are beyond the scope of what the industry offers today. Next week, we plan to unveil the world's first natural gas hybrid frac pump, part of our digi platform at the SPE frac Conference in Houston. This technology will have an even lower emissions profile than any electric frac fleet technology available today. Together with our existing fleet, our suite of pump and power technologies will enable fit-for-purpose customizable solutions. With the breadth of equipment, we will be able to pair digiFrac with dual fuel technologies to optimize gas consumption under a variety of circumstances. Customers will also be able to leverage a combination of available grid power and Liberty's generators to power fleet and consume any type of gas, including field gas, CNG or LNG. This suite of new technology developments will allow customers to have an optimized solution to match their needs. All will include a fully electric backside, proprietary quiet fleet technology and the lowest possible emissions footprint. We see a multiyear cycle favoring service companies that offer differential technologies, fortifying strong customer engagement and competitive advantages. We enter 2023 with strong competitive advantages that will enable further profitability expansion, including efficiency gains. [technical difficulty] Pardon me. This is the conference operator - we appear to have trouble with the speaker signal. We're going to put you on hold and get back to - reconnect to the speaker as soon as possible. Thank you. Please stay on the line. Pardon me, this is the conference operator. We've rejoined the speaker location. Sir, please go ahead. Apologize for the interruption a technical difficulty is there. I'm going to pick back up where I was - our free cash flow potential and strong balance sheet allows us to not only prioritize accretive share repurchases, but also to invest in our future. The goal is simple maximize the value of a Liberty share. In 2023, we are targeting approximately 40% to 50% growth in adjusted EBITDA with no meaningful change to our fleet count from today's levels. As we laid out in our Investor Day in mid-2021, we viewed 2022 and 2023 as years of countercyclical investment at the start of a longer strong earnings cycle ahead. Our 2023 outlook includes potential capital expenditures of approximately 50% of EBITDA, a similar percentage of capital expenditures as 2022. We would also expect to reduce - for that to reduce to the neighborhood of 30% of EBITDA in 2024. Our 2023 discretionary CapEx is driven by strong customer demand for next-generation low-emission frac technology in the coming five years. Our confidence in our long-term strategy and the strength of our operating model has never been higher, and we expect our investments today will lead to strong returns over the coming years. Our 11% - or 11-year annual average cash return on capital invested, CROCI, of 23% since our company founding was achieved during a relatively tough period for our industry. And before we had developed a suite of differential technologies and services that we are now rolling out. Today, Liberty is creating opportunity through ingenuity and innovation, not just in frac fleet technologies, but also in wet sand handling, logistics software and systems to optimize supply chains, predictive software, generating operational efficiencies and so much more. We enter 2023 with significant competitive advantages that enable strong relationships with the best producers and that drive demand for Liberty services far beyond our capacity to supply. These factors are likely to deliver rising free cash flow and strong returns to our shareholders in the years ahead. Liberty ended the year with very strong execution. In the fourth quarter, adjusted EBITDA increased by 7% sequentially in a seasonally weaker quarter, and we reduced net debt by $55 million, while we invested $116 million in capital expenditures and returned $64 million to shareholders. Our terrific fourth quarter results rounded out a great year for Liberty. Our team delivered 68% revenue growth, approximately $400 million of free cash flow generation defined as adjusted EBITDA less capital expenditures and nearly 50% free cash flow to adjusted EBITDA conversion ratio. We're pleased with our results and which we have now seen revenue growth in each of the last 10 quarters and profitability expansion through each quarter in 2022. At Liberty, our results would not have been possible without the hard work, dedication of our nearly 5,000 employees. Supply chain and logistics challenges offer opportunities for some companies will showcase the vulnerability and others. And the Liberty team came together to deliver industry-leading operational efficiency our customers have come to rely on. We have a unique combination of leading business or financial strength that reinforces sustainable long-term advantages. Our 2022 adjusted pretax return on capital employed and cash return on cash capital invested at 31% was the highest in three years, and we are on a path to surpass that in 2023. Our balance sheet strength allows us to focus on our priorities of investing and expanding our competitive advantages while returning a significant amount of capital to shareholders. Critically, we do not need fleet growth to significantly expand our margins. We have the tools, the technology and the people in place to expand our share of completion spend with our customers through a variety of technology investments we are making today. For the full year, revenue increased 68% to $4.1 billion to $2.5 billion in 2021. Net income totaled $400 million or $2.11 per fully diluted share. Adjusted EBITDA was $860 million, highest in the company history, seven times 2021 results. Our full year results began to show the full potential of the earnings' power of our platform that our team has carefully built over the years. In the fourth quarter of 2022, revenue increased 3% sequentially to $1.2 billion. We saw a healthy customer demand, and our execution excelled through winter weather challenges and disruptive supply chains. A full quarter of contribution of third quarter fleet deployment aided our results. Fourth quarter net income after tax of $153 million increased from $147 million in the third quarter. Fully diluted net income per share was $0.82 compared to $0.78 in the third quarter. General and administrative expenses totaled $49 million in the fourth quarter, including a non-cash stock-based compensation of $5 million. G&A declined $1 million sequentially, primary on variable compensation recorded in the quarter. Net interest expense and associated fees totaled $7 million in the quarter. Fourth quarter adjusted EBITDA increased 7% sequentially to $295 million from $277 million achieved in the prior quarter despite the usual holiday and weather challenges for Q4. Results included non-cash charges for the re-measurement of the tax receivable agreements of $76 million for the full year of 2022 and $43 million in the fourth quarter. These non-cash charges are all the noise related to the reversal of the valuation allowances recorded on our deferred tax assets in 2021. In 2023, we no longer expect the TRA to affect our income statement. We expect 2023 effective tax rate to be approximately 23% and our combined cash taxes and TRA payments to be approximately 10% for the year. We ended the year with a cash balance of $44 million and net debt of $175 million. Net debt decreased by $55 million from the end of the third quarter, even with the execution of $55 million of share buybacks and $9 million towards our recently reinstated quarterly cash dividend. Total liquidity at the end of the year, including availability under the credit facility, was $351 million. Earlier this week, we amended our ABL facility to provide a $100 million increase in net borrowing capacity to $525 million. In conjunction with our ABL expansion, we retired our $105 million term loan, reducing our effective interest rate. Net capital expenditures were $116 million on a GAAP basis in the fourth quarter, which included costs related to digiFrac fleet construction, capitalized maintenance spending and other projects. In 2022, we demonstrated the capital investment and higher rate of return opportunities and shareholder returns can both be achieved. We proactively installed a share repurchase program in July of 2022 to take advantage of the dislocated share prices - and we seized the opportunity to do so with $125 million in shares repurchased in the second half of the year. We also reinstated our quarterly cash dividend in the fourth quarter, equating to another $9 million paid during 2022. Our convictioning and a strengthening outlook and our ability to grow free cash flow positioned us to double the size of our original share repurchase authorization to $500 million this week. In our 12-year history, we have always taken the approach of investing counter cyclically in the early stages of the cycle, generating strong free cash flow, harvesting cash in the late stages. Our cash return on capital invested has been over 2 times our cost of capital during our 12-year history. Looking forward, we are targeting approximately 40% to 50% growth in adjusted EBITDA year-over-year in 2023, with no meaningful change in our fleet count from today's levels. In 2023, our investments are aimed at fully capturing a uniquely Liberty opportunity for differential returns. We have the premier design, the latest pump technology in the market. We are investing in the development of these pumps. We plan to own the value chain with our own power generation and the freight pump cannot function without this power. As we improved with sand and logistics controlling the full cycle of service provision maximizes long-term returns. This is a strictly different approach compared to some frac providers who lease technology and contract power generation from other providers. We are targeting capital expenditures of approximately 50% of EBITDA in 2023, similar to 2022. Comprised of maintenance spending and discretionary growth CapEx and fleet technologies, power generation, ESG-friendly wet sand handling and other high-return opportunities, included in this number some potentially accelerated early cycle investment spending that laid the foundation for earnings growth in 2024 and beyond. As such, we anticipate capital expenditures as a percent of EBITDA will decline to the neighborhood of 30% in 2024, following this infrastructure development. As we look forward, we are well positioned to maximize free cash flow generation to support our capital allocation priorities of disciplined investment to expand earnings per share, balance sheet strength and the return of capital to our shareholders. I closed our last conference call speaking about Russia's attack on Ukraine's energy system as their calculated way to inflict maximum human misery, regrettably those attacks continue. Unfortunately, the politically driven attacks on our own energy system remain ongoing as well. During the holiday cold snap, New England generated over 20% of its electricity burning oil. Why? Because by far, its largest source of electricity, natural gas plants were unable to secure enough natural gas at peak demand times. New England and an increasing number of states like California and New York continue to impose both higher energy costs and lower electrical grid reliability on their citizens, simply because the political and energy regulatory arenas no longer engage in honest sober dialogue about energy, the environment, climate and human well-being. The electricity grid is the most important network in the world. We demonstrated earlier the problems that can arise when a less important network, our telephone network can struggle as well. This, attacks on our energy system must stop or we will drive down American standards of living and de-industrialize our country just like Europe. That path is not looking too rosy right now. As not everyone is inclined to read our 100-page bettering human lives report that covers these issues. I made two brief videos last week to illustrate these points. One is called Zero Poverty 2050, and the other is called - let's be honest. The latter video garnered over 100,000 impressions on LinkedIn, but it was removed censored by LinkedIn three times in 48 hours, a video that simply lays out big picture facts about our energy system and climate change is banned by a business network platform. Either the LinkedIn censors are ignorant in this area or they are politically or socially motivated to protect the alarmist climate narrative that increasingly permeates our society likely some combination of the two. I find this alarming that a Microsoft-owned business is actively working to protect a false and destructive mean about energy and climate. The video is up now. Apparently, Torquemada approved it the fourth time. I'll conclude by saying that complacency is surely not a viable strategy going forward if we are to eventually reverse the damaging plague of energy ignorance in our country. Rent seeking interest groups will only grow in power as long as subsidies are counted in the tens and hundreds of billions of dollars. Hi, good morning, guys. Just wanted to expand on the gas market comments so, what would relocating capacity look like? Would you expect to displace customer fleets in oilier basins or would these be incremental fleets to the market? Just want to know what this could mean for pricing? Is there any threat to the downside or is there ability to price up as you move fleets over? Derek, first of all, I'd say we view this as pretty unlikely. I think we'll see some modest contraction in industry activity. It doesn't likely impact Liberty fleets in gas, less than 20% of our capacity is working in gas areas. But in an extreme case, if it did displace a fleet, it would be quite easy for us to move that to another area. And that would more likely - we've got a lot of people constantly calling and trying to figure out what it would take to get a fleet. So - we would have no trouble placing that fleet. Yes, ultimately, that would likely just slide into an existing program where our customer is using a lower quality player that they have no choice but to use. But I think that - the gas market concerns, I think, are real, but I think they're overblown on their potential impact in the frac market. Total industry-wide, this might be a few fleets we have today probably 10 or 20 fleets demanded that are simply not there. That's not just Liberty but just industry as a whole. There's activity not happening because people don't have a fleet so that - it might be something, but it's - not likely meaningful to the frac market. Got it, okay. No, that's helpful. I wanted to touch on your EBITDA guide for 2023. You said a 40% to 50% growth over 2022. I'm just curious like - can you maybe unpack that a little bit? What's locked in today? What gives you the confidence that those numbers? Do you have pricing locked in for all 23 - or is it just capacity and pricing is more of a moving target? I'm just curious what would drive upside to that estimate maybe what would drive some downside to that estimate. Just if you could expand on that percentage forecast you put out? I mean that forecast comes from what we know today. We're never big on seeing wildly different things in a crystal ball. So the market is strong today. That's sort of existing market conditions continuing on. We have relatively low risk of keeping our fleets busy. We have ongoing internal technology efforts that drive down our cost of operations, and we'll continue to push those forward. So I think it's sort of an extrapolation of where we sit today. Michael, I don't know if you want to add anything to that? Yes, we had great visibility. We have very low customer turnover and we have kind of strong visibility into our customers' plans for the balance of the year. So barring any exogenous change in the world those plans will continue. So - we have a strong view. As Chris said, I think there's upside is self-help cost reduction as we move more to, sort of expand the shoulders of earnings of the business. The downside is sort of exactly the same as you say and exogenous events that changed the world market. Thanks. Good morning, everybody. Two things from me, just to start with, when we think about - I mean obviously, you gave some color on 2023. When we think about your positioning in the market and some of the things you've done on the vertical integration side, I mean, obviously, you got some frac sand from the SLB acquisition. Are you seeing - how do you see - because we've been hearing about tightness in the frac sand market recently? Are you seeing that as sort of a competitive advantage? And how is that kind of increasing or helping the efficiency at the well site. I'm talking of frac sand, but also the other things you've done so anyway to kind of give us a little more color on how those things kind of aid in your execution at the well site? Yes, the primary benefit we have by owning sand capacity, we've invested to expand it a little bit. The primary benefit of it is just surety of supply to our fleet. We saw the benefit of that in Q1 of last year, where there were troubles across the sand space. And we were able to navigate those with less impact than others. Vertical integration for us, sure, these are profitable businesses, but we do it predominantly to assure our core business of frac could run reliably and can keep that train on the track and run that train as fast and efficiently as possible. The markets are tight, but it's - I don't think it's slowing down fracking wells. It's - we're not at a disruptive part in the sand market right now. Great, thank you. And then the other question and you've talked a little bit about this on prior calls and how you sort of approach the use of the buyback, but you - clearly, you've doubled it and you've been utilizing it. How should we think about your - the sort of the pace of buybacks over the next 12 months and your willingness to kind of exhaust this as we go forward here, depending on valuation, et cetera? Yes, as we said, it's just the - the pace at which we buy back the stock is proportional to the dislocation of the share value. And today, as we sit here, we're still in an extremely dislocated share price. So we see it as an incredibly attractive investment opportunity right now to buy our stock back. You've seen us walk that walk the last five or six months and with share prices in this neighborhood, I think you will continue to see aggressive buybacks. Question here, with this backdrop of an expanding gas diesel spread, I'm curious whether there's any mechanism within recent contracts for digiFrac or on dual fuel fleets where you can capture some of the incremental fuel savings that your customers are benefiting from. Is there any direct way that you guys can benefit from the kit that's providing these savings is it, direct may I know? I mean, we're bringing the technology and the equipment that enables the realization of this arbitrage. So yes, I think it's fair to assume that the majority of that arbitrage value will be captured by Liberty. And yes right now, that arbitrage value is growing - is growing. Is it direct, Chris, though or is it just indirect through your ability to keep a healthy rate structure or is there a direct mechanism that wins it somehow to the gas diesel spread? We're pretty early on in rolling out these technologies, it's a smaller piece. So today, I would say it's mostly indirect, but you'll probably see an evolution of that structure going forward. Okay, yes it will be good to see. And Michael, just real quick on the CapEx just to make sure I got the numbers right. The 40% to 50% EBITDA growth, it's about $1.25 billion, and we think about half of that is around $600 million for CapEx for the year. Is the right way to think about it? Hi, thank you. I'd like to follow-up on that - that last point there about '24, and I know this could get a little tricky, right, because you probably don't want to give a financial forecast for '24. But I'm just curious, on an absolute dollar level, do you see the CapEx going lower or going meaningfully lower kind of regardless of what the EBITDA does or how should we think about the absolute amount of CapEx as we go from '23 to '24? Yes, our investment in CapEx, Marc, is never ever dislocated from the amount of money we earn or the EBITDA or cash flow we earn, right? There is - sometimes in time shift where we see the market strengthening, we invest early in the cycle. And then when strengthened prices and EBITDA grow, EBITDA is the highest, we'll do low CapEx because, obviously, if we see sort of a cycle beginning to cap out. So there's some time shift there, but it's always, always relates to the amount of cash flow that we are earning right? So just to sort of point that out, right? But no, in relative - terms, in the baseline business of the size and who it is an environment, yes - on a normalized - on a per dollar basis, it would be lower in '24 and we estimate to be lower in '24 than it would be in '23. Do you think that level - so if - let's just hypothetically say EBITDA is exactly the same in '24. Do you think that level of CapEx is a sustaining level where you can continually pursue these digiFrac deployments and sort of handle attrition that occurs every year in the fleet at that level? Okay, okay, super. The other one I had was on just the digiFrac deployment. Maybe you could talk a little bit about expectations for a timeline to have a full digiFrac fleet, because it seems like we've just got a few pumps sort of mingled in with conventional pumps in the fleet right now? As we said in the transcript, we're continuing operations with that first customer for it at full speed right now frac operations, which gives us the luxury to roll things in slowly and carefully, test everything, figure out how to optimize everything. So it's a gradual roll in. But I think you'll see around the end of the third quarter, maybe early in the second quarter, we should see three digiFrac fleets out there running in full. Oh, sorry about that - end to the first quarter, beginning of the second quarter. I misspoke, not for the first time today. Hi, good morning team. Just to understand the thought process in case we do see a strong drawdown in the number of active fleets and pricing does come under pressure. At what level would you say it is better to stack a fleet than accept lower pricing? And then what would you think that the industry on the whole would be willing to do in terms of pricing concessions? Ati, that's a great question hard to give much of an answer to that. The market - we don't see any signs of weakening right now. The market is strong. Of course, someday, the market will weaken. Don't know when that is or how it will fall. Our relationships are one-on-one with particular customers. So look, and you see a softer market, there's also efficiencies. There's other ways to drive well cost down then lowering our net price if the market as a whole to supply we get other materials and run operations. But you know we've - as I mentioned in our intro, we've gone through sort of eight tough years in frac with the giant track fleet overhang, even when activity bounced back strongly in 2017 and 2018, there was just dozens of surplus equipment parked all around. So that was just a different dynamic than we are today. And we were a younger company, establishing relationships, proving ourselves very early on in developing and rolling out our new technologies. We're just simply in a much different place today that I can't predict - future swings up or down in pricing. But I don't think you'll see anything dramatic in the foreseeable future there. Yes, I'll just add Ati - from a general perspective, if you talk to other players. As Chris said, the market has completely changed, right? It's not this access sort of equipment that was made to be reactivated at any given time. So any swing down will be a smaller percentage of the total fleets available. You've got a much more consolidated market across the board for frac. And we are, as an industry, one hell of a lot more disciplined, right? And so yes, I think you're going to see a lot more disciplined effect with net pricing kind of not moving, nowhere near in anyway the shape that you've seen over the last seven, eight years in these small cycles that were well oversupplied, comparative to what is going to happen in the next five years. That's just my personal view. Thank you, I appreciate - the answer there. And then Michael, maybe can you talk about the free cash flow and working capital changes this quarter? And how should we think about that in 2023? Yes, I mean we had a small build in working capital this year. That's mostly driven by sort of year-end prepayments and inventory. Next year, obviously, working capital will be a slight build as it follows revenue, Ati kind of really just you can model it with revenue. I think that's a relatively reasonable number. I've given you the cash tax number for next year is sort of around 10% of pretax net income. And other than that, really, CapEx is the main sort of next main deduction has got very low debt, obviously very low interest. Yes sorry, '23 so for 2023 cash tax is around 10% of pretax net income obviously we see CapEx around about 50% of EBITDA, interest is relatively diminimis, because we got - it's relatively small amount of debt and those and we're going to have slight build of working capital as revenue is going to increase from Q4 levels through the end of the year, but that will be relatively small. Hi Chris, I had some questions on kind of the rollout of digiFrac, you're taking kind of a modular approach, which makes sense. But I was just wondering if you could comment on how performance has been in the field and what you're seeing in terms of that technology? And just perhaps to clarify, so you'll be adding three fleets, did you say at the end of the 1Q, but your overall guide is for relatively flat fleet activities. So are you taking some diesel fleets out of the - out of the working fleet? Yes, our plans for digiFrac rollout this year will dominantly been replacement fleets [so come] and get. Market conditions are pending, but that's the plan right now, dominantly replacement capacity, basically an upgrade, which is an upgrade both in the performance of the fleet. It's an upgrade of reducing our cost of operating that fleet. And of course, it's an upgrade in that the pricing port is better. We bring something better for our customers with a lower all-in cost to us. I'll turn it over to Ron to make any more technical comments about that. Look, as far as performance going well, we always expect when we put new technology in the field. We got a bit of a learning curve with that, but things are going well. We're actually in between pads right now with the operator. We had wrapped up pumping consistently on the last 45 or 50 stages on that with all the pumps that were on location at that point in time. We'll begin with a slightly bigger fleet on the next pad and excited about getting the rest of that fleet out likely by the middle of February. And then we'll have the other ones follow on quickly after that. Great, thanks a lot Ron. And another question for Chris is, given the retrenchment in natural gas prices, including Waha, are you seeing - do you expect this perhaps to accelerate the attrition of diesel fleets just given the cost competitive benefits of running dual fuel plus the emissions benefits? So yes, that - very low Waha prices and outlook, they may stay there for a year or two. Certainly, that grows the arbitrage between the two, but the arbitrage was large already. And it's a lot of capital and investment to bring out a new fleet and swap them over. So it makes it incrementally more positive, but I don't think it's a big enough move to speed investment contracting decisions any meaningful amount. Thank you, a great quarter. So my question is - with respect to Canada versus U.S. margins. In Q4, what were the margins like between Canada and U.S. were they par or one was higher than the other? Generally, as you know, we don't discuss it from basins really. Most all of our basins are not Canada as a country - my favorite sport in the world hockey, but it's the same size as some of our U.S. basins. But in reality, I'll tell you the only real difference between the two markets is the Canadian market is probably not quite as tight yet as the U.S. market on frac supply. So that's the only real change. If you have a difference between the two different markets, right? So the other than that - other than that everything else sort of remains, it's fairly similar across the North American onshore [indiscernible]. Yes, and have you added any new capacity into the Canadian market? And then how many maybe Tier 4 fleets do you have in Canada? Waqar, we don't want to give the details on that. But certainly, there's optimism in Canada, new pipelines, at least on the horizon of coming in of activity levels there. But -- so we're always in dialogue with customers. We never do it on a - we're going to add to this basin or take away from that basin. It's always just a customer specific decision we make. Thanks Waqar. And another question, if I may, what was the impact of weather on the quarter? Could you maybe quantify that a little bit in terms of revenues or number of jobs or anything? Yes, pretty normal. And so - I think you guys all heard me say that kind of Q4 and Q1 are generally somewhere between 4% and 8%, depending on the year lower than the summer quarters. So Q4 was a pretty normal year as far as that in the midrange there. And we're expecting Q1 to be about the same so probably activity-wise the two winter quarters will be relatively flat with a bit of a pickup in some. Hi, good morning, and thanks for taking my questions. Maybe if we could just start out on pricing. It looks like the guide implies EBITDA per quarter, roughly what you saw in Q4 and if fleet count remains flat, it sort of implies that you're not building in much more pricing, but maybe if you could just talk a little bit about how you're seeing the pricing environment unfold, both on the leading edge and in moving your average fleet up to that level, that would be helpful? I mean - as we said, pricing is strong right now. The market is good. So yes, there's still some - most all of our pricing is already adjusted. There's, a little more adjustments we're getting in Q4 from older. I mean, in Q1. My guess, I got to get my calendar straight. So again, there's still a little bit of positive action happening there. But market is strong. Markets are tight, and we're just not making much of a guess on where things go from here. But it looks like things will stay strong. Are there forces that can push them up further sure. Perfect, thanks for that. And not to try to steal too much of your thunder from the event next week, but can you maybe just give us a little bit more comment on the hybrid frac pump? What -- will it be involved in these next digiFrac fleets that you're putting out or what's the timing on that? And what's really the, I guess, the business case for the hybrid pumps now? Keith, this is Ron. Yes, I can give you a little bit of color on that. Really, the third leg in the stool in our digiFrac platform. And probably the quickest and easiest analogy I could give you would be something like the power grid. Chris talked a little bit about that earlier today. But think of this new pump as baseload power force, sort of like a nuclear power plant on the grid. So this is basically a little brother to the same power plant we're using on the generator. So 100% natural gas engine, extremely efficient, 44.5% thermally efficient so very, very good at the use of gas. [indiscernible] thank you for the same reason we chose that engine for generating power much, much better than a turbine on location, either in a direct drive application or in a power generation application. In this case, we're connecting it to a transmission and a pump, but we're also taking some of that power to run a smaller generator on location. So we're using the primary power to drive the pump and provide horsepower. We're using a small amount of that power to generate power electricity, enabling a fully electric backside. The unique thing about this engine is it's a single speed engine. So it doesn't have throttle control to it. It's made to run it one speed and one speed only. And so, it's not made the deal with Transient, which is how it pairs so nicely with our digiFrac electric pump. Together, the combination of those things works just like a nuclear power plant with a gas peaker plants on top of that. So we have this combination that delivers flat baseload capacity, strong and steady, incredibly efficient. And then on top of that, to deal with regular transient load we have in the frac space, we've got digiFrac. So you'll see those two going out into the field in partnership with one another. The exact ratio of those two pumps is really going to be a function of what the customer situation is like, what - the frac needs are like, what our access to maybe some grid power looks like, all of those things will play into the exact ratio of how we deploy those. I was hoping you could assist us with just some market capacity framing. What percentage of the industry's active fleet, is diesel models regardless of the tier? And when it comes to that pure diesel horsepower, what are your expectations for upgrades to DGB vis-à-vis new-build replacement? In other words, to the extent we see a portion of that industry diesel horsepower convert over the course of 2023, would you expect the mix to be between new-build replacement versus upgrade and maybe an idea of just how much you are expecting? But there's still a large amount of diesel capacity out there. It's still - the dominant source of powering frac fleets today. There's, older Tier 2 fleets that people are putting sort of these aftermarket kits to make natural gas burning. That's not a huge cost, although the supply chain struggles there. So there's a good amount of that going on. But longer-term thing, I think as you were hitting at, is going to be what happens to those Tier 2 diesel engines, basically, which are all five to six years old, and the average age of them is probably a decade old. So those are falling out. And as you said you can either, take that same pump and buy a new Tier 4 - more likely Tier 4 DGB dual fuel engine and put that on the deck or you can build a brand-new natural gas-powered fleet technology. So most of what's going to happen, I suspect in the industry- for those that are investing for the next thing is going to be taking those Tier 2 engines and making a Tier 4 engines. The bigger players have electric options for us, it's - we're trying to develop, and I believe we have developed technologies that for us will be both cheaper and better. And that's why we spent years doing it. The history of electric frac fleet has actually been more expensive and worse. Now there's, more fleets that are maybe a little better, but they're more expensive. We're trying to solve for both of those cheaper and better with our next-generation technologies, a lot of investment in getting here, but we like what we said. Understood. Let me give Ron some more airtime, two-part question for you, Ron. First, for the three digiFrac spread you expect to have deployed by 2Q? Which should we expect those to be powered by - will they be on the Rolls Royce MTU gas gen-sets? And then maybe I'll push for a bit more of a sneak preview on your upcoming event. But under operation 1440, could you give us updates on two technology initiatives, preemptive maintenance and then automation? Yes, so to your first question, absolutely, you're 100% right. Those fleets are all going to be powered by the 20V 4000, the Rolls-Royce natural gas recip engine. We've - we like that power plant. It's the most efficient power plant in the space. And so it will be paired with every one of the digiFrac pumps that we put out in the field for Fleet 1, 2 and 3. And then that same power plant, just a slightly smaller version, the 16 cylinder going on digiprime. And then as you - you think about the other piece of that puzzle, we made tremendous strides last year in both of those areas. As you think about the preventative maintenance side of things, we launched the team in January last year with a strong focus on moving forward in that preventative maintenance side of the world. I would say we made huge strides, and we saw that in our cost of maintenance last year, our ability to - run our equipment at, well - really flat maintenance costs in the face of very, very strong inflationary pressure. So that's a credit to that team and the work they've done from a predictive maintenance standpoint. The amount of intelligence we have or insight we have on our equipment today, probably orders of magnitude beyond where we had been in maybe three or four years ago so huge stride there. Artificial intelligence, of course, we're moving rapidly towards full deployment of our next-generation fleet operating software. Really a piece of software that effectively enabled us to tell the fleet what rate we want to achieve and the maximum pressure that we can pump at and the software is making all the decisions about how to run those pumps optimized for gas substitution or whatever we might ask of it. But those decisions are all driven by a computer going forward. Hi, good morning guys. I want to just quickly go back on the 2023 guide, adjusted EBITDA up 40%, 50%. I think you said you're pretty much extrapolating current market conditions, but I think I heard you say pricing is stepping up a little bit in the first quarter, which is again expected rate? But again, if you can quickly walk through 2023, how should we expect activity and even more so pricing moving from the first quarter to the fourth quarter? Because it sounds like you're assuming things pretty flat, but I want to make sure we understand the assumptions, especially on pricing through 2023 in that guide? Right so yes, so pricing relatively - in those numbers, pricing is relatively flat through 2023 activity. Obviously, you know winter quarters are in that 4% to 8% lower activity wise than your summer quarters, which is the standard. You should all be modeling just for winter weather and holidays. And yes, it's really not a huge amount of kind of fleet number changes. That's what's baked into those numbers. Yes, okay, okay perfect. And then a little bit of a clarification on CapEx. Obviously, the implied number is in that $600 million to $650 million range. It's stepping down in 2024 that makes sense. But can you quickly walk through the different components in that 2023 CapEx number between maintenance new digiFrac actually any upgrades that you're doing to the traditional fleets and then anything on the vertical integration front, just so that we can look at the individual components and better understand what part is falling off in 2024? Yes, I mean I'd say - kind of maintenance is in that realm of probably $170 million to $190 you know standard, right so, between three and a half from the fleet plus $25-ish million for the other ancillary business lines et cetera. And then really, we haven't given the breakdown on the other side of it Sara and the majority of that obviously goes to margin expansion projects. Obviously, the big dog in that one is the electric fleet for digi equipment that we're rolling out. As I sort of alluded to, some of that with supply chain is, in a little bit of an accelerated build the things that will come online early in 2024 as margin expansion for 2024, where the CapEx will appear in 2023. Okay, okay perfect. And just a quick clarification before I turn it over, should we assume digiFrac build cadence to remain the same in 2024 as in 2023 or should we assume it can change depending on the market conditions? It will change depending on market conditions. Obviously as it - it depends on market conditions, whether it's the earnings that we're going to end up with EBITDA, the amount we will spend on CapEx and the speed at which we rolled out to digiFrac. So I just wanted to ask, any appetite for dividend increases or is the idea to use the buybacks as the flywheel for shareholder returns? What would you kind of contemplate a dividend increase or what would you need to see to do that or again, is the buyback the kind of the flywheel? Well, buyback is definitely the flywheel. Just look at the different investment opportunities we have today and some of these technologies we've talked about, the outlook for them is simply tremendous and buybacks are just simply tremendous opportunity today. So that's the big dog of where capital will go. We are believers in dividend. We paid a dividend before the COVID downturn as well. But we're a cyclical business it's always going to be cyclical. We want to have a base dividend that barring a global pandemic that stays and gradually grows with time. So I do think you'll see growth in our dividend, but it's not a major swing based on market conditions or better this than that. It's steady as she goes, but certainly the outlook we have today is likely continues to grow. Great, thanks Chris. And then maybe just kind of a high level one, some fundamentals for the industry definitely still appear very strong. And I guess I just wanted to ask, what would you view as kind of the biggest near-term risk to your outlook? You mentioned that you think nat gas, activity declines is a relatively minor risk? But like would a deeper than anticipated recession be it demand concern or a faster supply side response, what kind of metrics would you suggest investors pay attention to and assuming they play out as expected, that would mean that your outlook remains intact? Yes, we hear a lot about the faster supply side response, but as we hit, we view that is a relatively low risk. It's hard to grow frac fleet capacity. It's going to grow a little bit, but it isn't going to grow a lot. The thing that can change the market faster, as we've seen in the last downturns is a collapse in commodity prices. The risk - to our business is a collapse in oil prices. And so you think about financial crisis, right? We had a very large scale, very rapidly unfolding collapse with the financial crisis. And it took a tight oil market with oil prices over $100, and it crashed than to $30. And it actually made two or three not great quarters for the industry and things came right back because going into that recession, supply and demand was tight. And supply and demand is probably at least as tight probably a little bit tighter today than it was then. So I think a huge rapid economic contraction would certainly soften the industry, but even then probably not for too long. So it's really oil demand. So watch oil prices. If oil prices go to $40, activity is going to drop. Hi guys, thanks for working me in here. I know we're getting long in the morning. But just really quick, one of the questions earlier was around diesel versus electric frac. Maybe I'm going to frame the question a little different. What's the optimal mix of digiFrac in the Liberty portfolio, I guess, number one? And then number two, remind us what the average expected life of the digiFrac unit is versus a traditional unit? Look, I think the general working life of these diesel pumps is 10 years that's rebuild. There's a lot of maintenance goes on after that, but pumps that are more than 10 years old. The technology is obsolete. The cost of maintaining and run there so they're generally falling away. You may see a 12-year-old pump out there. There's some - there are some stuff really hanging on. With digiFrac, we definitely expect meaningfully longer life than for a diesel engine. It's just simply - the engine life on our banks, Ron maybe 2x. Or time between rebuild is probably 3x, Sean. So we're going from maybe somewhere in the 20,000, 25,000 hour range to a time between overhauls of maybe 84,000 hours is the nameplate number for that Rolls-Royce engine. And the thing you should think that they - that's more reduction in capitalized maintenance along the engine of the life of the equipment. The life of the equipment might be longer, that's great, but really what it does. It affects the annualized capital maintenance and brings it down. That's for keeping it yes we want to deliver a better quality pump, a better quality fleet at lower long-term costs. That's going to evolve with time. I believe we're there or we'll certainly be there at having a solution that's ultimately cheaper and better. So if you're going to build, you're probably going to build what's cheaper and better. But our build pace is going to be, as Michael said, dictated by the marketplace, but it's going to be slow and gradual. It's got to make sense - and you got to have compelling economics, you've got to have a willing to allocate ex amount of capital there. So our fleet probably slowly migrates to all whatever is cheapest and best. Thank you. And then maybe one more, just I think earlier in the call, this was mentioned, but I don't know that we got a clarification, just sand facilities and any efforts to expand capacity there or - of your existing facilities and/or your desire to build new ones in the current market? Look, the key - sand is a key ingredient for frac. That's our focus on sand. We've got to keep our fleets and our customers' wells on time and without interruptions to operations. So yes, we've invested a little bit in debottlenecking, increasing our throughput in there. We'll make investments to what it takes to secure that Liberty's operational performance and deliver to our customers is the best in the industry. That's what drives our decision-making there. This concludes our question-and-answer session. I would like to turn the conference back over to Chris Wright for any closing remarks. Thanks, everyone, for your time today and interest in this business. Liberty and our industry as we demonstrated networks, matter and sorry about the problem with the phone network, we'll prevent that from happening in the future. Everyone, have a good day. We look forward to talking to you at the next call.
EarningCall_1402
Hello, thank you for standing by. And welcome to the EMCORE Corporation Fiscal 2022 Fourth Quarter Results Conference Call. At this time all participants are in a listen-only mode. After the speaker presentation there will be a question-and-answer session. [Operator Instructions]. Please be advised that today's conference may be recorded. I would now like to hand a conference over to your speaker today, Tom Minichiello, Chief Financial Officer, please go ahead. Thank you, and good afternoon, everyone and welcome to our conference call to discuss EMCORE's fiscal 2022 fourth quarter results. The news release we issued this afternoon is posted on our website emcore.com. On this call, Jeff Rittichier, EMCORE's President and Chief Executive Officer, will begin with the discussion of our business highlights. I will then update you on our financial results, and we'll conclude by taking questions. But before we begin, we would like to remind you that the information provided herein may include forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Exchange Act of 1934. These forward-looking statements are largely based on our current expectations and projections about future events and trends affecting the business. Such forward-looking statements include projections about future results, statements about plans, strategies, business prospects and changes and trends in the business and in the markets in which we operate. Management cautions that these forward-looking statements relate to future events or future financial performance and are subject to business, economic and other risks and uncertainties, both known and unknown, that may cause actual results, levels of activity, performance or achievements of the business or in our industry to be materially different from those expressed or implied by any forward-looking statements. We caution you not to rely on these statements and to also consider the risks and uncertainties associated with these statements and the business, which are included in the company's filings available on the SEC's website located at sec.gov., including the sections entitled Risk Factors in the company's annual report on Form 10-K. The company assumes no obligation to update any forward-looking statements to conform such statements to actual results or to changes in our expectations, except as required by applicable law or regulation. In addition, references will be made during this call to non-GAAP financial measures, which we believe provide meaningful supplemental information to both management and investors. The non-GAAP, measures reflect the company's core ongoing operating performance and facilitates comparisons across reporting periods. Investors are encouraged to review these non-GAAP measures as well as the explanation and reconciliation of these measures to the most comparable GAAP measures included in our news release. Thank you, Tom, and good afternoon, everyone. Q4 represented a major turning point for EMCORE, as it accelerated its move into aerospace and defense, with the purchase of KVH and the continued integration of the former L3Harris space and navigation team. EMCORE is now the largest independent provider of inertial navigation solutions. Putting us on a runway to being a much larger business in the future. Consolidated revenue for fiscal Q4 was $25.6 million with 82% coming from aerospace and defense and 18% coming from broadband. Cable TV represented less than 8% of the company's revenue. Changes of this magnitude presents significant operating challenges under any circumstances. And in Q4, the changes created significant turbulence in our operating results, generating an operating loss of $10.8 million and adjusted EBITDA of negative $9.4 million. Our non-GAAP operating loss was $6.3 million and adjusted non-GAAP EBITDA was negative $5.1 million. Tom will provide color on Q4s gross margin, but I will start off by saying that margins were affected by a number of events that are not expected to repeat themselves going forward. In the aftermath of COVID, the cable TV industry itself continues to struggle underneath the overhang of a demand bubble that caused nearly five year’s worth of products that were built within a two-year period. The players in the industry are also changing as well. In our last call we pointed out that Cisco decided to exit the cable TV equipment business. However, just last week, ATX publicly announced that they licensed the entire Prisma II technology platform from Cisco, allowing that technology to move forward. While these developments are expected to improve cable TV demand over the longer term, we don't expect them to provide a meaningful catalyst for recovery in the next few quarters. Semiconductor availability slowed down shipments for wireless and chips within broadband in Q4, as our customers were not able to get enough silicon to shift transceivers and DAS systems to meet their own internal projections. With that said, our chip business continued to get additional traction with customers in the form of engagements and planned growth and shipments. Going forward on the chip business, we expect to see a ramp -- see the ramp get a bit steeper during this summer, setting the stage for much stronger FY '24. To conclude my statements about broadband, I'd like to return to a statement from our last call, in which I made the point that cable TV was increasingly incongruent with our strategic direction. Today, I would update this to say that we've made meaningful progress on resolving the strategic map mismatch between core and non-core assets in our direction in aerospace and defense. Turning now to aerospace and defense, I'll begin my comments with our Chicago operation, which was formerly owned by KVH. During Q4, the Chicago team met the shipping goals we set during due diligence, and began the integration process. We subsequently identified two development programs that needed help to get back on schedule and were able to get them back on track. The combined efforts of the extended engineering teams in Bud Lake and Concord allowed shipments of these new products to begin in the December quarter. We also began to lean on coil winding technology and supply agreements that originated in Chicago, validating important scalability and cost synergy arguments that we made in favor of the transaction last summer. Chicago has a strong book of orders, and is now able to begin the production ramp for several of their new products. I would also point out that they were recently awarded several new contracts, the largest of which is for over $30 million for five years worth of production. The space and navigation team continued to make solid progress on the new T-A-I-M-U or TAIMU long-term navigation grade IMU, even as it continues to meet shipment targets for board. These two systems are critical to the launch schedule for United Launch Alliance, or is part of the boost stage flight control for Atlas Centaur and Vulcan launch vehicles, well TAIMU will be the primary IMU used for navigation. Critical milestones for TAIMU are set to happen in the March quarter, as well as the beginning of product builds in Alhambra. Our expectation is to complete qualification late in the calendar year to enable significant volume builds and launches in calendar year '24. When these products hit full production, they're expected to produce $20 million to $25 million annually in revenue. The QMEMS product line continues to recover its order book from the Civil Aviation downdraft that happened during COVID. We are getting more 777 x orders, along with a significant uptick of demand for inertial systems used in business and regional jets. In Q4, we shipped all of a critical precision guided munition or PGM order for an important international customer. We're expecting that this will enable us to be qualified for larger domestic contracts as well as exports. As we've said before, PGMs are the largest market segment for inertial measurement systems, and are expected to be an area of significant growth for EMCORE in FY '23. Beyond this customer, we are working to test and qualify the SDI170 with defense contractors worldwide. In a recent international trip, I was advised that annual target volumes range from one to 4,000 units per year, with a total value of approximately $30 million. Before I move on to guidance, I'd like to focus a few comments on the integration of space and navigation and the former KVH team. One of our key objectives in this year is to make all four of our manufacturing facilities work like a single entity. As of today, space and navigation is now running a common ERP system with the rest of EMCORE and is made the cutover from L3Harris's IT system. This will enable us to exit the costs of the transition services agreement that was part of the transaction. Chicago is running about a quarter behind space and navigation. But we've already moved the Rhode Island engineering team out of the KVH building. While cutting costs is important. The true benefits of scale are only realized when we have all the facilities on common ERP, MES, and PLM systems. We began rolling out Camstar MES for shop floor control and Alhambra and expect to integrate this into the other facilities after we complete the ERP upgrades and exit transition services. Ultimately, this will make EMCORE more efficient, and will help us improve our processes and reduce OpEx and inventory. Turning now for guidance to the current quarter, we continue to see weakness in the cable TV and wireless markets. Although we will make modest gains in chip revenue, it won't be enough to offset the weakness in cable TV. Inertial Navigation will see growth largely driven by a full quarter's performance out of Chicago. Consequently, we're expecting revenue in the $25 million to $27 million range for the December quarter. Thank you, Jeff. Consolidated revenue for fiscal 4Q was $25.6 million with 82% coming from aerospace and defense, and 18% from broadband. Aerospace and defense segment revenue was $21 million, a $7.6 million increase when compared to the prior quarter. The A&D revenue growth was largely attributable to the addition of the Inertial Navigation operation in Tinley Park, Illinois, located just outside of Chicago. That was acquired from KVH Industries on August 9. In addition, the rest of the A&D segment was collectively up by $1.5 million or 11% on a sequential quarter basis. A rebound in sales of QMEMS products following supply chain shortages during the prior quarter, increased space and navigation revenue and higher fog shipments all led the way, partly offset by lower defense Optoelectronics revenue. Broadband revenue was $4.6 million, a $5.7 million decrease when compared to fiscal 3Q. $5 million of the drop was due to the continued downward slide of optical transmitters and lasers sold into the cable TV infrastructure market. These products generated revenue of $2 million in the quarter, compared to $7 million the quarter before and compared to $29.5 million in the fourth fiscal quarter of last year. Clearly this time around, we are in a much deeper cable TV down cycle than the company has experienced in at least the last 10 years. Non cable TV broadband revenue was down $700,000 due mostly to sales of wireless -- I'm sorry to sales two wireless customers. Chips and sensing revenues were essentially flat. Let me now turn to the rest of the operating results, the focus of which will be on a non-GAAP basis. Consolidated gross margin of 2%, compared to 18% the quarter before was impacted by several factors that include the following. First, 4Q was the first full reporting quarter for the space and navigation business in Bud Lake and included higher than normal costs due to the timing of revenue and cost recognition under its percentage of completion accounting method. Second, the Chicago Inertial Navigation business was acquired in the middle of the quarter, and included prorated cost that resulted in a gross margin for the partial quarter significantly below levels consistently achieved in the past. Third, our QMEMS operation in Concord included two non-recurring charges, one associated with a revaluation of inventory to a more recent/lower component costs, and the other was an adjustment resulting from a full fiscal inventory count taken at year end. Fourth, for the broadband segment. The low gross margin was the result of the aforementioned drop in cable TV revenue, and continued under absorption of overhead costs, including the Alhambra wafer fab. Many of the factors related to the two recently acquired operations in Bud Lake and Chicago are transitional in nature. And we expect once fully integrated that both businesses will return to their historical margin performances, or better. Operating expenses were $11.2 million in fiscal 4Q, compared to $10.5 million in the prior quarter, due largely to the inclusion of the Inertial Navigation acquisition for part of the quarter. Before moving to the bottom line, it's important to highlight that EMCORE has undergone a momentous and rapid change to the revenue profile. The first half of fiscal '22 accounted for 60% of total year revenue, during which time broadband accounted for 75% of the business. In just a couple of quarters later in fiscal 4Q, this has completely flipped to over 80% of revenue coming from aerospace and defense. The company is now better positioned for higher growth, with a broader base portfolio of Inertial Navigation products, expanded customer reach, and in a substantially larger and more stable marketplace than the highly cyclical cable TV market. There is no doubt A&D is our future. We are now the world's fourth largest and largest independent provider of Inertial Navigation solutions. Our fiscal 4Q results reflect the significant and swift changes to the size and mix of the top line. Together with the gross margin items I just outlined, as well as the need to invest in future growth, 4Q operating loss was $10.8 million, adjusted EBITDA was negative $9.4 million and net loss was $10.9 million or $0.29 per share. Shifting to the GAAP results for a moment. Fiscal 4Q net loss was $16.9 million or $0.45 per share. This included one-time transaction costs of $5.2 million associated with the acquisitions. The GAAP results also included two non-cash items excluded from the non-GAAP measures, a $3 million long lived asset impairment charge associated with the Alhambra fog operation and a $3.1 million accounting credit related to the reversal of variable incentive comp accrued during the first three quarters of fiscal '22. Turning to the balance sheet, we had cash of $26.1 million at September 30, compared to $75.1 million at June 30. The $49 million decrease consisted of $55 million to acquire the Chicago Inertial Navigation business, $2.4 million representing the second and final payment related to the space in Nav acquisition, $5.2 million in acquisition transaction costs and $1.8 million in CapEx. Offsetting these uses of cash was $15.5 million included in cash from financing activities, which represents the borrowing level at September 30, under a credit facility entered into with Links Fire Capital at the time of the Inertial Nav acquisition from KVH. Before we get to questions, I'd also like to cover a couple of other recent events. First, the integration of our two acquisitions involved a recently completed management reorganization and cost rationalization initiative. This included a reduction enforce designed to reduce costs and expenses by a total of approximately $3.6 million annually, split between roughly 55% cost of goods sold and 45% OpEx. We expect to record a charge in the December quarter for related severance costs, which we anticipate will comprise a combination of accelerated stock vesting and cash over time. Second, as announced last week, we completed the sale and leaseback transaction of the Tinley Park property obtained as part of the Inertial Nav asset acquisition from KVH. This transaction generated $10.3 million in net cash proceeds. Okay, great, guys. Thanks for taking my questions here. Like the first one is on gross margins. Tom you mentioned a number of items here that you're seeing are one time in nature. I don't want to repeat them. I think there are four of them. The broadband one certainly makes sense. It seems like other ones are potentially transitional here. One, if you could help us understand how much magnitude that added two COGS in the September quarter? And ultimately, how do we think about what are you thinking about for gross margins for December? So, the total of let's just stick with the A&D side, where we had the two acquisition, gross margins, and are the charges that I mentioned, for Quartz MEM in Concord. So, when you take all of those and the impact in the quarter, and you adjust for that, you're taken an A&D gross margin up to, call it, high -- mid to mid to high teens, 16% 17%, just with that alone. And so you're getting back to even better than where it was last quarter. And, there is other activities and things that we've have done with this business as we integrate the acquisitions. And as we do things in the Quartz MEMS operation with yields and prices and things like that, that put us on a much healthier trajectory. Okay, do you want to try to quantify what you're thinking about that for December? I think, given your 11 days from the end of the quarter verse, so here, it seems like you'd have a good view on what that is. So, good start with A&D end number here in the mid-teens 16% 17%. But how would you put this all together here? Yes, I think that number is if you just sort of adjust for the items that I outlined in the prepared remarks, the way to think about it is, so A&D between the changes we're doing in Quartz MEMS and the acquisition integration, I would call it mid to sort of low to mid 20% range for A&D. And if you -- so the issue then becomes for the consolidated gross margin, broadband isn't going to be all that much better. Because it's cable TV down cycle we're in is not going to improve for several quarters. So you'll see that continue to struggle because of the just the size of the revenue alone. So, when you put it together, you're looking at a consolidated number, 20% plus or minus, maybe a little bit higher 2021 '22, if things go well. That's just in the December quarter. Because a lot of the things that we're doing have some impact in the fourth -- in the December quarter. But for example, the reduction in force that we just talked about, that happened late in the quarter, kind of early December, so we'll get a little bit of that in the December quarter. But that'll most of that will take full effect in the March quarter. So as we take those kinds of actions, and we do other things to on the integration front, some of the things that Jeff mentioned, in terms of getting everybody onto a single system that would come sort of towards the end of the March quarter, and you'll start to see an improvement through the fiscal year on gross margin. Okay, so to catch that last part here. So going back to the reduction of course you said $3.6 million annually with 55% of that in COGS here. So, sounds like there's been relatively little if any of that happened so far. It happened fairly late in the December quarter. It sounds like it won't be coming into COGS necessarily immediately, so it might take a couple of quarters to see the benefit from that rip? Yes, okay. I hope I said three. Yes, okay. So, yes 3.6. And so, that's when 900 a quarter. So you're looking at roughly, 500 in cost of goods sold and 400 in operating expenses on a full quarter. And since we took the action at the early part of the last month of the December quarter, just a few weeks ago, you'll see you know the full impact of that in the March quarter. Hey, Richard, let me -- here's Jeff. Want to give you two other little pieces of color here. So, for example, one of the things that we're not expecting to repeat on the gross margin line. Hey, the good news is that we nearly doubled yield, of course for the congruent humans products. Bad news is we took an inventory valuation hit that was enough significant in the quarter. So that's the sort of thing that we're actually expecting see some benefit from but it hurt us in Q4. The other the other thing to think about in terms of the RF is that really is EMCORE continues to simplify its business. We are going to simplify the management structure. And remove the folks that had positions that were more, let's call it more broadly considered part of a larger set of BUs. Right. So what it does is it just it collapses the BU structure, it eliminate positions, because we're simplifying the mission of the company. Okay, fair enough. Jeff, let's talk a little bit about kind of top line here. Your guidance for the quarter is clear. It sounds like it's mostly coming from the additional months of the KVH operation here. I think we've been hearing about some constraints in supply chain in parts of the business and QMEME is among other things. So, maybe kind of talk about the trends here, how much is being held back by supply or other dynamics here? And then how do we think about that going forward into March quarter? Yes, so, it's an interesting problem, because the supply chain issue in primarily semiconductors, we weren't hit too badly in some other places, where connectors, oddly enough, are still an issue. But what we've seen is customers push back for that are expecting chips shipments, because they actually can't get enough silicon to build transceivers and or the distributed antenna systems used in wireless. But what we're expecting to see, because what we are now getting shipments of circuit boards, that aren't going to help us much in the current quarter, but they will help us in March. So I would expect to see March look better from a supply constrained perspective. Okay, fair enough. And then last question, I'll jump on line here. See, there's other ones out here. But just kind of putting this all together and thinking about when you guys get to breakeven, and what that looks like, if you could give us any thoughts. I'm guessing, probably more interested in the structure than timing, because it seems like we're looking at a few quarters, at least here. But maybe both of you can talk about the structure here when you get to breakeven. Sure, so yes, it's several quarters out, Richard. And, with improvement, quarter-by-quarter until call it sort of the back half of the fiscal year, potentially early FY '24, it's going to depend on a lot of factors. The revenue will need to grow into the $30 million to $35 million range on a quarterly basis. And if we can hit sort of the middle of that range, with a mid-30s gross margin, or we can get up to like 35, with a sort of maybe even a lower gross margin. I mean, there's a lot of moving pieces here. So, somewhere in that sort of 32 to 35 topline with a gross margin in the low to mid-30s would put you at adjusted EBITDA breakeven if you tack on sort of a forecast for operating expenses. Yes, so Richard the other the other thing to point out here, and it echoes Tom's remarks a bit, is that the gross margin number is constrained more by overhead absorption than you might think. When people look at gross margins, oftentimes they say, oh, prices are collapsing in the market, or your costs are out of control. But the reality is overhead absorption, high fixed costs in facilities that have 30,000 gallons of liquid nitrogen, for example, are a significant factor. And so as I mentioned in my comments, one of the important things that's about to start happening in the March quarter is, we are going to be building a high volume high end navigation product – long-term navigation product that was designed in Bud Lake, for ULA, and that will make a significant dent in this volume/margin constraints that we've been feeling for a while now. I think also the signs are positive in Chicago. Now that we've collectively cleared out a few things with a new product, which we just announced, that if you asked me about tech 450. And the whole generation of those products from the former KVH team, they are now shipping in volume. So all of that will start to really make an impact, I would say in the March quarter. Right. So, Tom's got the numbers, right. Qualitatively, it's about overhead absorption, it's not about driving the material costs down, or the prices up, although we are instituting a 10% price increase on Quartz MEMS doesn't affect all of our contracts, because some of those are locked in for a period of time. But certainly for new orders, that is going to help us a bit and it's just about recovering the higher costs of semiconductors mostly. Thank you. One moment for question. [Operator Instructions] Our next question comes from Tim Savageaux with Northland Securities, you may proceed. Hi, good afternoon. My first question is on the cable side. I know it's a small part of your business now. And I guess getting very small, I mean, looking at the guidance, I think we must be headed to zero in the December quarter or somewhere pretty close to that. And you frame it in the context of kind of a broader down cycle in CapEx, but that's not really what we're seeing, with regard to Charter talking about a multi-year investment program, and most suppliers actually having pretty decent years, even near term. So I guess my question was -- I'm kind of searching for the disconnect there. And there are several potentials, whether it's Cisco abruptly exiting the business. I know, you've mentioned inventory builds before among several customers. And of course, the final factor, maybe we are at a point where some of the linear analog technology is moving out of the network more quickly. If you look at those three factors, how would you assess at least what looks from my perspective, covering half a dozen plus names in the universe, this sort of disconnect between what EMCORE seeing in cable and what others are seeing? Sure, I'll tackle that one, Tom. Real simple. It's five years worth of lasers and transmitters that shipped in two years for COVID. And a large fraction of that was never installed. And so it's sitting in the warehouses of CommScope. And it is sitting in the former major distributor of Cisco product in the U.S. And so the overhang is there. EMCORE is not a broad based supplier of many different cable optics products. And so that's where the concentration is, we had a terrific run up big profits, because we were so efficient during the trip down, -- but I'm sorry, during the time that we were running in big numbers. But the interesting thing is here we are, with $2 million worth of cable. And believe it or not, it's still making a little bit of a profit. And it's because we became efficient. That's how we were able to do we did during COVID. But the reality is that the pile of inventory is there as what our customers are telling us. They are actually selling more linear EML transmitters to try to clear out their warehouses. And there's just nothing we can do about that. There's no competitive losses. And the back end of the cable business, certainly with nodes and amplifiers, is has done very well. And will continue to do well. But no, for us, it's mostly about inventory that's out there. Great, and just -- and thanks for that color. And just to follow up on that, you made a comment about making progress, I guess on the strategic front in terms of cable? I mean, it sounds like you guys are preparing to exit that business. Do you have any color you want to add on that? I wish I did, wish I could, Tim. As soon as we've got some to say we're going to get it out there as fast as we can. Okay, and then last one for me. One of you might be able to take just a quick moment. And because you went through a number of programs that you were working on the chip side, I think last quarter, maybe a couple quarters ago, spanning Datacom, telecom sensing. It sounds like you've been making some progress there. Have you added to that? And, I know you mentioned supply issues is maybe a gating factor. But how does that opportunity look compared to what you saw a quarter or two ago? Yes. So, there are, I believe, and I'm trying to think of exactly when it happened. So I could be off a little bit. I believe we've picked up one more program in Q4 from an existing customer. And the production shipments that we talked about are moving, as we said they would. They just haven't picked up as fast as we'd hoped and what our customers are telling us is yes, because we can't get enough silicon oddly enough. The sensing piece over in China, which is run through China rail in Shanghai, for example, they've had COVID issues and continue to and so if people stopped even in the offices, I know, it seems a little strange, given how much progress there's been in Europe and in the U.S., but in parts of China, it's still an issue. So, I would say that – and we talked about it being transceivers, these are chips that are used in tunable lasers. Beyond that, I'm not allowed to mention customer names. But hopefully that gives you just a little more insight into what's going on. There's just a lot of silicon shortages in that business right now. Sure. I'd like to close by thanking you all for your interest in EMCORE. I also want to recognize our team for their perseverance as we reinvent the company as an aerospace and defense business. And finally, I'd like to wish you all a wonderful holiday season and Happy New Year. Thank you.
EarningCall_1403
Good morning and happy new year to everybody. My name is Chris Shibutani. I’m the U.S. large cap pharmaceuticals analyst, and I’m going to cover some of the biotech and biopharma sectors. So I was really pleased to see the expectation for performance out of both of those. Outstanding. We are thrilled to kick off the year literally. This is the start of the year and with Merck being able to be the first voice as the industry and the investor community comes together once again and we look forward to 2023, where obviously expectations for the performance there. Really pleased to have joining with us Mark Davis, CEO and now Chairman as well, which I think is an interesting context. Also our slide should be updated for that. But I also did want to express a special thanks to the entire Merck team. Peter Dannenbaum in the Investor Relations group is here as well, made extra effort. Everybody is going to be going through quite a deluge next week of news and information. And if San Francisco weather forecasts on my iPhone are correct, deluge in terms of rain as well. Pack an umbrella. So I think I want to also thank the entire Goldman Sachs research healthcare team and our conference planning efforts here to organize this, it's great to be back in person for this. And I appreciate all of you who are coming here to join us, especially this morning, and as well to people who are online with the webcast. So looking forward to connecting. So Rob, as you have been, I think the last time we sat down and talked at the Goldman conference in June. So it's kind of a periodic update. And I really appreciate you making the effort to come here and talk to us in person here, and really be the cornerstone for our discussion through this event today and really to start off the year here. Can you talk about how you're feeling in your role? I think last time we kind of colored you as a newbie, because it had been kind of 12 or 16 months, like when people have a baby, they stop talking about the month, age and weeks of age. But you’re also now the Chairman. So talk about reflect a little about 2022 how you're feeling about the state of the business, and thoughts that you're you know, prioritizing as we kick off 2023? Sure, no, I appreciate it. Well, first of all, thank you for having me in. And obviously, 2022 for Merck was, was a really a phenomenal year. So and I give all credit to my colleagues around the world, and everything they did. But, if I look at where I see the state of the business, I would tell you, the business is healthy, our results are strong, we're growing, and we see good momentum in the business. I feel very good about our key growth drivers, they're intact. They're continuing to, to deliver, whether it be in oncology in vaccines, in our animal health business. And probably most importantly, our pipeline is progressing. As I look at it, and think back 15, almost 16 months ago, as I stepped into the role of CEO, and where we are today, I can tell you my competence about how the business is progressing, the progress we've made over that window is quite high. And it gives me a lot of confidence as I look forward. So whether you talk about scientific performance, commercial performance, operational performance, all going extremely well. As we think about priorities coming into 2023, largely, it's the same as what they were in 2022. We continue to focus internally, I'm always saying, especially to the commercial side of the business; we have to focus on operational execution and discipline to continue to deliver in the short term. And I think we've shown to the pandemic of resiliency and an ability to do that that is something that we are very focused on. But obviously, I know that the value long term for us is our ability to drive sustainable growth. And that is about the pipeline and what we're doing there. So we're very focused on how do we continue to invest in, but probably more importantly, accelerate, and then augment the pipeline. And that's something we've been focused on in 2022. It's going to continue to be in 2023, and years forward. And then lastly, it's about how do you transform the business. We know the world is changing. We need to be faster, we need to be nimbler. That's something I push, we're trying to drive for more focus, more simplification. What I always say internally in the company is focused on what matters, put the patient at the center, do that, move with urgency as one team. Always think about it. As we are within Merck, we always talked about the fact when a crisis happens, we rise and we address it. I try to tell everyone internally, there's a crisis every day, that's when one of our family members, someone we know, is suffering from some medical condition. Keep that in your mind. That is what we're focused on, stay there and drive for that. And that's about skewing everything else pushing everything else to the side and driving for that simplicity. The Organon spin was an enabler of that. It's helped. I see that operationally, when I'm out in meeting in the markets, their ability to focus on the key areas of the business are stronger today than it was. I see it in our labs. I’ve seen it in our manufacturing operations. So that that move is working. We need to continue to do that more. And we have to embrace digital and data. That's a big area for us, especially in discovery and development, but frankly, across the whole piece of the value chain. And then lastly, how do you think about value demonstration and probably most importantly, driving access? We talk a lot internally about how can we continue to expand access to our medicines? Globally, it's influencing our R&D strategy. It's influencing our commercial strategy. So those are the key areas. And then lastly, I put it last because it's foundational not because it's least important investing in our people. We don't do anything else if we don't have great people. And so that's, that's what we're thinking about. That frankly, were -- was the priorities in 2022. That's what we're going to continue to focus on in 2023. And as I said, I continue to believe that's what we'll look at as we move into the future. But I just summarize it is, the business is strong, and I'm feeling good. That's very reassuring to have. The continuity, there's a lot of echoes and and similarities with what you've articulated. Really, since you've been in the seat as well, I think the strategy has to be somewhat long in arc, and having that consistency is very valuable. You did start off by talking about the pipeline. And clearly, everybody is trying to solve for that sustainable growth dimension. And what's clear is towards the back end of the decade, as much as KEYTRUDA has been successful, it represents a challenge in the post 2028 period. And that always brings front and center when any investor is communicating with us, and we're having discussions with Merck about capital allocation, and the M&A strategy, which you guys have been very upfront about making clear that it is a priority for the company. Perhaps again, at this juncture, this time of year, gets you to reflect back a little on 2022 and 2021. And think about how it's perhaps shaping your thoughts on 2023. 2022, I would argue you were a little bit less active, right? So on Pandion in 2021.2022 broadly speaking, business development is not just headline generating conference call iterative kind of M&A. But there was a little bit of less activity there. So this pipeline, any color you can give us in regard to what shaped that 2022 sort of M&A result, and maybe how you're thinking about strategy in 2023? Sure, no, yes. So if you look at it, and, again, it's very similar to the theme of the comments, I made to your first question. Our strategy has been unchanged. In 2021, we were very clear. We said we understand we need to move with urgency, we need to move with focus. We continue to believe we had opportunities in our internal pipeline. We needed to accelerate those. But there was a recognition we needed to augment those. And I think you saw us move very quickly, when I became CEO with the Acceleron deal. At the time, it seemed like a, a, from my perspective, it felt like a risky bet. It was a large transaction as a new CEO. It was for Phase II asset. As it worked out, I think it's been a wildly successful transaction. All credit to my scientific colleagues. They were the ones that came forward and said, Rob, this is a meaningful area. We knew the PAH space, because we had an inhaled SGC working in that space. They understood the space, they understood the opportunity, and they said, this is something real. We need to move. And I put confidence and credence in their conviction. And I'm glad we did because I think you saw the results from the STELLAR study. We're just really a phenomenal and we're very excited about what that means is a if you will a foundational element of a growing cardiometabolic pipeline as well. But if you look in 2022, we came into 2022, with the same focus, we had in 2021. Obviously, we I would say our activity level in 2022 was no less than in 2021. Our ability to successfully bring deals to fruition was a little bit less than 2022. But frankly, hopefully what you take from that is we act with urgency and focus. But we act with discipline. I'm confident in the future. We don't have to move and do things. We do them when we see a strategic alignment. Scientific value is always at the core of what we start with. If we see a scientific need, if we see an opportunity, if it fits with our strategy, and then if we can get to value we’ll move. And, sometimes it works. Sometimes it doesn't, but we hold to the discipline. But if I look at 2022, in total, I think people because we did a lot, frankly, in the last month and a half, two months of the year, I think a lot of people actually probably aren't giving credit to that. And the other thing I would just comment on people in this and I understand why but people tend to want to flash up a large acquisition, or an acquisition of any kind. Often the best deals look what we did with ESI. Look what we did with AstraZeneca, collaborations and partnerships that give you access to great science, especially where you have insight into the science can oftentimes give you opportunities than an acquisition won't because not everything is there to be acquired. And so we look for the best science and where we see it based on relationships we move. If you look at what we did, the collaboration we've done with ORION, giving us a very interesting asset in prostate cancer, targeted therapy, very complimentary to the growing position we have in prostate cancer. What we did at the very end of the year with the acquisition of Imago, giving us access from a hematology perspective into blood-borne cancers and continuing to grow that. Those are both very important assets. Both companies we knew well, Imago we had an early investment in so we were tracking that. So you should assume when we've moved, we've moved because there's scientific rigor behind our decision. And then, obviously what we did with Orna, for circular RNA, interesting in longer term capability, we announced some deals for a suite of ADC programs with Kelun late in the year, building on an earlier program we did with them, we have a actually a TROP2 moving into Phase III ADC that we're very excited about. We've been able to accelerate and in combination with Kelun. And then finally, we did the deal with PeptiDream for peptide conjugate drug antibody approach. So, I look at all of those, and importantly, at least several of those, Imago, ORION. And then the one biggest one, I didn't mention, the personalized cancer vaccine with Moderna, all of those are going to be Phase III programs in 2023. That's 3 Phase III program just from those alone and the TROP2 will be moving into Phase III. So I just gave you 4 important assets to this company that we have access, not through traditional acquisition in every case, but important business development. In each case, based on the understanding we built over a relationship and every one of those cases that were years in the making. Right? I imagined that there are just so many things that factor into the calculus within the war room about thinking about doing deals, you and several other management teams have articulated, and a value proposition that is inherent with the partnerships. How much would you say from Merck was related to and you talk about having kind of this M&A pipeline, you're mindful of keeping an eye on certain opportunities that have potential there. How much is sort of related to your own decision making, and perhaps of the party that could be across the table, whether you engaged or not, versus there were quite a few things that happened. When you and I spoke in June, the FTC was having a very public panel in terms of talking about across different industries, but specifically within healthcare, about, their voice that they will have as regulators to M&A we had in August, at that time, the IRA and those implications, interest rates, were not going in a helpful direction as well, how much was external versus sort of Merck and potential target specific? In most of what you saw in 2022 was based on what we saw as the great scientific opportunity where we could align value and where we couldn't align value through an acquisition. And we could get it through collaboration or partnership. That's what we did, where we couldn't align on value overall, we walked away. We held discipline, because, as I said, we are focused, but we're not desperate by any stretch of the imagination. Most of that was all driven by what we sold the dynamics in the marketplace, as we dealt with partners, less so about implications from the FTC, the IRA. I mean, obviously, those are things we factor, and we can talk about that they definitely have an implication. But as we saw in 2022, it's not causing us to change course or not do something we otherwise see the scientific opportunity, the strategic fit and value. And I don't think it will in 2023, either the strategy in 2023 is going to be the same as it was in 2022 and as it was in 2021. Got it. And you mentioned that obviously, the Organon spin was a fundamental restructuring of the portfolio. And I think I'm becoming a little bit notorious given the seat that I'm sitting in to talk to you about the animal health business. Can you give us your latest and greatest in terms of your view about the appropriateness of the animal health business with the human health and the fit there? As we look at it, we always are very objective about understanding the portfolio and the dynamics of the portfolio as a whole. As I sit here today, I continue to believe that looking at the growth profile of the animal health business, what we've been able to do through investments in it to drive its innovation, to drive its growth, and what will be the drivers of its performance over the next several years, continue to believe there are stronger synergies with Merck and our ability to drive those together than if we drove them independently. So as we sit here today, I continue to see this as a core strategic asset for the company and one that we will continue to invest in. And it's a, I view it as a large and growing product that is an annuity like revenue stream, that is a great diversification for the broader business and one where we can invest and where it's a top performing asset. So to me, it's something we should continue to, to invest in and keep as part of the portfolio. But again, that's not a forever statement. And it's not a philosophical belief. It's based on objective analysis we do on a regular basis, we just always come to the same answer. Let's talk about within the human health pharmaceuticals, portfolio, therapeutic areas, obviously oncology has always been kind of the center of gravity, very consistent in how you articulated the aspiration to continue to maintain leadership in that whole sector broadly speaking within oncology. In the past year however you have highlighted quite a bit and things that have been actionable had been more in the cardiovascular realm. Vaccine is another very significant presence that you have. And as I go through comments the management team has made, you have not been disregarding certainly keeping an eye or doing discovery work or early development work in areas like cardiometabolic, immunology. Neuroscience often gets mentioned. I think, when we were over visiting you guys, you talked about how may not have been headline generated perhaps the largest number of specific business development type engagements, whether it was a licensing, we're actually in the neuroscience field. So you're in many different areas. Talk to us about how you're thinking about the therapeutic areas and prioritizing that as you're looking forward to building that pipeline? Sure. As we look at it, and I think our approach has been consistent. The therapeutic areas important, but in some ways, it is an outcome of the decision. It's not the driver of the decision, it starts for us. Where do we see the best science? Where's the best science? Where do we see an unmet need, where the science matches it, where we believe we bring some capability to really harness that and deliver something for the future in the form of an invention or innovation? That always is the first thing we ask. Now, that being said, and you've heard me in the past, say, I want to be portfolio informed. What I really mean by that is I'm not blind to the realities of the portfolio. But I don't ever believe that the best way to do it is to say, I'm going to start saying I want to be in a therapeutic area. And then I tried to go buy something, because I think that can lead to bad decisions, because it might not be the best area to invest at that time. If you look naturally how it works, I think it tends to evolve into being diversified or evolving over time. It's interesting, you started your comment, saying, well clearly you guys are an oncology company. Well, when I joined Merck, in 2014 Ken’s reason for trying to bring me and his selling point was, look what we will be in oncology. But the first meetings I had with investors were, what the hell does Merck know about oncology? Fast forward, here, we sit in 2022. And we're a leader. We had JANUVIA. We were leader in diabetes. I think we've shown that we can pivot to where the opportunity is. As we sit here today, there continues to be real opportunity in oncology. And I think we can leverage the position we have with KEYTRUDA to take advantage of that. And we will. That being said, we have seen in our own pipeline growing opportunities in the cardiometabolic space. And obviously, that led us to the Acceleron deal, but we have a suite of programs internally, we're very excited about. And I think we will see us be a major player in the cardiometabolic space going forward across the whole suite of opportunities, both late stage and even stuff we're seeing coming through early stage which we can get into. But the oral PCSK9 or Factor XI, we can go through the whole range of those several programs and Nash. That is an area where we will continue to invest. And then as you said, on from an oncology perspective, Dean has been very focused on looking at immuno oncology and understanding that the first half of that is the immune system. And so we are now leveraging our understanding from immuno oncology to move into immunology. That led us actually to Pandion. The IL-2 mutein, that we did that's part of the Pandion deal. Actually, our learnings for that came from that same mechanism from an oncology perspective, space, we leveraged into the non-oncology. So often something you turn off on one side and the oncology side, if you turn it on, it does something else in the immune system. So it's allowing us to learn and move and immunology an area where you're going to see us continue to invest and grow. And then as you mentioned, from a neuroscience perspective, we don't have a lot in late stage. We have 2 Phase II assets. We have a Phase II asset and treatment resistant depression, another one in schizophrenia. But we have made probably the biggest dollar investment from a collaboration perspective in the early space in neuroscience, and we're going to see play itself out. So I'm very focused on understanding the portfolio. If I have the choice to diversify between two equal things, I will take the diversification but always I start with the science, and that drives us. And if we do that, we will be robust, and we will have consistent solid long term performance. And how do you think about sort of like capabilities or platforms or modalities in that context? For instance, it sounds as if the mRNA the mRNA deal enhanced some of the long historical trends that you've had with that. Are there any particular areas that you feel that you're more keen to perhaps fortify? Yes, well if you think from a, and I would say this is something the Dean has brought a little bit different. It's a nuance from where we've been historically. Obviously, we've always said a platform for platforms sake is dangerous. But where you can find a product that brings a platform there's a real opportunity. And Dean is very focused on understanding that and driving that. And so we are much more balanced, I think today and thinking about platform and product. And as we think about technology platforms, clearly we are investing in mRNA. We did it through our partnership with Moderna. We're doing it on the personalized cancer vaccine, we have internal programs of our own, we're looking at next generation technologies to the deal we did with Orna. So that is a technology platform, we're continuing to roll out. The macrocyclic peptide technology, that's the basis of our Oral PCSK9. We think that same technology can apply to a lot of historically undruggable large molecules. That's something we're very interested in. And we're continuing to drive ADCs is something that we continue to believe are important. That's why we did the deal with Kelun. We've done multiple deals, we're building our own capabilities as well. So we are balanced and thinking about the platforms. We are understanding. We want to be diversified and touching them. We've often talked about cell therapy. We're now starting to do more in cell therapy, particularly, as we look at how do we see the opportunities if you can move it from an allogenic space and into a solid tumor. We've got several deals. One I would have highlighted with Dragonfly as an example, with their TriNKET technology, I try specific, natural killer cell approach for cell therapy. So we're in all of the key areas, what Dean has always said is, we're not going to go what is neat, and sexy, we're going to wait till it's ripe and robust. And but we move and we stay nimble. And I think we've shown we can leverage that. So it's a balanced approach with approach between product and pipeline, as we think about how we then we think, the total portfolio of assets we have across the different therapeutic areas. Got it. Of course, the Holy grail is both sexy and robust. How are you feeling about like the importance of having a really significant asset versus this diversification which you seem to be describing? Yes, well, I in the end of the day, you have to always balance, making sure you don't spread yourself too thin. And I will tell you, what Dean has brought and what he continues to espouse within the company. He is very much with me around this notion of we have to move with speed and urgency. But I would say the thing that he's brought, probably the strongest and I actually use him internally as an example to the rest of the company, is focus. Dean always starts with let's not talk about what we are going to do. Let's talk about what we're not going to do. And so, I don't want to give you the sense that we're casting our net wide when I think we're casting it appropriately. But we're very focused on making sure we move things forward quickly, and see success, as opposed to moving everything forward, slowly, seeing nothing get over the finish line. So it's a balance. But I think we've struck the right balance between enough breadth to make sure we're for a company of our scale and size, we can absorb it and we can prosecute it. But we haven't lost that focus and my competence in that comes through how I watch Dean prosecute the pipeline, how he prosecutes the challenges he puts to the scientists, as they try to bring forward ideas. Got it. Touch base with you on something that you actually were very good about commentating consistently through last year. And it's the environment and valuations in the broader ecosystem, particularly with the small cap potential targets, potential prospective partners there, there was significant focus on whether there would be any evolution or shift or change in the expectations for kind of at what valuation they would be willing to reach across the table and shake hands bid ask spreads, so to speak, though your latest view on whether that has shifted or appears to be in position to shift? I think our experience has been obviously we've come in a little bit about that on why we didn't get more done in 2020 and 2022. But as I look at where we sit today, you have seen a pullback in the biotech sector. But my own experiences right now, I don't think you can apply a monolithic approach to how you're thinking about it, because what we're seeing is most there are companies clearly who are becoming cash constrained amount of capital flowing is less. But the reality of it is most of the companies with really intriguing science that are showing data, they're getting access to capital. They're getting funding. They are becoming the haves and the have nots, and the haves who are doing well who frankly, would be the ones that you would want to go after their views of value haven't changed. If anything, they continue to expect a significant premium. And if you look at some of the deals have been recently or if you've watched the prices of some of the assets that have had positive data readouts, I think it shows that that even the market is understanding that. So net net, as we're out there in discussions I have not seen a fundamental shift in expectation from the seller side that is if you will make things cheap from the buyer side. There still are premiums being demanded but I continue to believe there's opportunity to get deals done if you're very diligent if you're selective and you look where you find some value proposition that either is asymmetric to what others have, or that others have been fully identified, go back to Acceleron. I think we saw the value in Acceleron before others did. We moved ahead, we got the data and before others. In other cases, I think we bring real capability, a lot of what we've done in the Oncology space is because people want to partner with us because of the opportunity to access and what KEYTRUDA brings. So whether it's asymmetry of information, or synergies, or us taking a position based on our own scientific belief, there's opportunity, you just have to be selective in how you go after it. Got it. And then to touch quickly on a couple of items that are typically in Caroline’s script, she has often articulated that you the company for the right opportunity is not constrained in terms of capital structure, and that you'd be willing to take a one notch downgrade, if that was part of the total picture. Any update on that? Does that remain the case? Our view remains the same. We are for the right strategic move, we would take a temporary one notch downgrade. I don't see it as something necessarily we have to do. But if the opportunity based on the criteria, I've already laid out scientific fit, strategic fit, value demonstration aligns, we'll move but if I don't see that we're not going to move. But the short answer is if the right thing would present itself, meeting all those criteria. Yes, for the strategic move, I would take the down rate grade because I believe long term growth in our business through new science is what creates value. And I'll invest behind that and use the balance sheet, but it has to be a strategic fit. And it's not something I feel like I have to do, it's going to be based on an opportunity where I see clear value creation. Got it. And then to run off the capital allocation discussion, share repurchases is something that's also in the toolkit. Comment the latest there, Caroline had referenced, I think, during the third quarter call that potentially that there would be more visibility on that in the event that a transaction of size didn't appear to be timely, I forget the exact wordage. But share repurchases. What is that… Yes, well, so I think what we really we've been consistent in first and foremost, we're going to invest in the business, we’re going to invest in our pipeline. If we have capital leftover, obviously, we're committed to our dividend and growing the dividend. But if you have capital after those, it's in my mind, investing into the business growth through augmenting our pipeline. And bringing in science is a better use of funds than a share repurchase. So our priority has not changed. But we've also been very clear to say, if those things don't materialize, I also don't believe sitting on a lot of excess cash for an extended period of time, creates value, we will return that. But I want to make sure I don't foreclose an opportunity to invest to grow the business by doing it. And as we sit here today, no different than what I indicated. On the third quarter call, I do see several opportunities that we're still looking at. And I want to let this all play itself out before we commit to a share repurchase. But if those things don't, and depending on what we see at that time, when we truly believe we're in a situation where we have excess cash, we will return it. Got it. And let's talk about an aspiration that you've described, which is to continue to grow through the -- of KEYTRUDA in 2028. And there's some clear strategies with consistent descriptors such as extend and expand, that you guys have used as part of the vernacular at Merck. Amongst those efforts, some of the key readouts don't play out until 2024 to 2026, there's kind of that span. So here, we said at the start at 23. Talk to us in terms of how much that is factoring in your decision making? Do you need to see those results? Are you still proceeding with the same degree of alacrity? Even ahead of those results? What is the role that those readouts will play? Well, I would say those one, as I started with the original comments at the start of the presentation, my competence today, over the progress we made in the last 15 months is much higher than would have been then it frankly, we made more progress in those 15 months than I would have expected. So if we can continue to demonstrate that kind of growth, both through continuing to accelerate and see maturation in our own pipeline, and continue to augment it the way we've been doing, the LOE period for KEYTRUDA will take care of itself. I'm more focused on do we have a sustainable engine, and don't take from those comments. We were very focused and I'm moving with urgency. But, but I'm doing it in a space where I feel I have competence, that we have a path forward. If we can just continue to execute the way we have, we have a path. So I feel very good. And you might say well, why? Well maybe just to give some senses of it you go back 12, 15 months ago. We weren't telling you we expected over $10 billion coming from our cardiometabolic portfolio with a potential losses. Sitting here today based on the STELLAR data outreach readout we had, I even feel more confident about that. If anything, I think the numbers bigger, because I think the opportunity with what we have sotatercept is even is coming sooner and likely to be bigger based on the strength of the scientific data we're seeing there. Plus, we're seeing all the other programs moving forward. With oral PCSK9, it’s moving. The Factor X11 is moving, all of the programs. So as we sit here today, that gives me a lot of confidence. That's over $10 billion in the mid-2030s. If you look from a, an oncology perspective, I just listed off to you 3 Phase III studies that if we had talked six months ago, you wouldn't even had in your mind that are going to be starting in 2023. And in oncology, those move quickly. T0hose will have an impact in the 25 to 2030 period, there's more than just those. I just happen to pick 3. There's more, right? So you look at those and say, those are meaningful new opportunities that didn't exist. And then you look at our own internal pipeline, the way VAXNEUVANCE is starting to show opportunity in the pediatric space, what we're seeing with V116. In the adult space for pneumococcal disease, meaningful opportunity. We just recently in December, you may be missed it our partner, Bhutantan read out Phase III data from their from their dengue study, for a vaccine against dengue in Brazil. This is very important, because we have been doing our own Phase II studies using fundamentally the same vaccine that they have. The fact that they showed such strong data with a single dose now allows us to think about how do we accelerate bringing our own dengue vaccine to the rest of the world where we have rights. Recall that deal. They have rights in Brazil, we have rights to the rest of the world. Half of the world's population lives in an endemic area for dengue. That's huge. That's something that's not on anyone's radar screen. That's an underappreciated opportunity. That all came just in December. And so I'll stop there. Because I don't want to use all the time, I could frankly, use all the time just giving you all these. But I think you get the point. Things are moving, things are moving, the team is responding. The urgency is there. We are delivering. So I sit here today and feel very confident about where we are. And from that perspective, we'll see where it goes. But you should hopefully take the message of my confidence. I went so long and forgot the questions you asked. No, no, no, not at all, actually. And I think so much of what we're perceiving and the value of being in person for these events is that we see your body language, the confidence, the ability to iterate beyond what might have been. This is CEOs unscripted, and what's clear is that you can reel through all sorts of areas to have -- as we move into the second part of our two hour conversation that we're going to have here, but I mean, there's plenty to talk about. And certainly I think the Street is going to do a lot of sharpening of pencils because I think for vaccines, we think about GARDASIL, we think about the PNEUMOVAX, et cetera. But what goes beyond that, and you really helped us articulate that. A couple of specifics with KEYTRUDA. So under subcu formulation, and I think you've highlighted that you're going to do the hyaluronidase version of that a little bit. Can you just talk to us about reasons behind that decision? I think Eliav sort of mentioned that during some industry events. And how quickly can this possibly come to market? Yes, so just to for just not everyone's familiar is where we are on this, we have two programs, we're looking at to move in with a subcu approach for KEYTRUDA. And one is in combination with hyaluronidase. And one is through a dosing formulation. The reason these are so important as we look at our strategy and expect you mentioned as far as extend, expand, deepen that we've talked a lot about. When we look at KEYTRUDA what you see is the drug that is foundational in the treatment of people with cancer. But what sometimes we miss is while it is phenomenal, and it's really unprecedented and what it's done. The reality of it is average overall response rate is 30%. Strong duration could be better. Efficacy depends on the patient. So you might have a response, the durability, and that is based on the tumor type and the patient. There's still a significant opportunity to extend KEYTRUDA’s value to patients. And then the last one is that relates specifically to the subcu is if we were successful in moving into earlier and earlier lines of therapy, which we right now we have 6 approvals in areas in adjuvant new adjuvant space. We have right now 20 registration enabling studies underway to move others into that space over 100 studies being done in total in that space. So this is very important to us because it allows you to start to move into earlier – in earlier stages of disease, and to treat patients and to hopefully drive cancer from a death sentence to a manageable disease. That's ultimately the goal. As you do that, as you get patients earlier in the disease, the last thing someone wants to do if they believe their life is somewhat returning to normal, because they were caught early, and we were able to address it is think, Gosh, I'm going to have to go into a hospital. And I'm going to have to be hooked up to an IV and be infused and sit in a chair. I’m not going to have to do that every 3 weeks or every 6 weeks for years, no one wants to do that. If you can save that patient, what, you don't have to go to the hospital, you can do it in an alternate site. And you can do it through a subcu formulation. That's a benefit. That's a true patient benefit. That's an innovation. And I think bringing real value to patients. So I start there, because that's the most important thing. With that, that should allow us to continue to allow people to see a differential benefit, we bring through KEYTRUDA with earlier indication, and a combination in subcu. And in the case of the co-formulation with the hyaluronidase, if you look at that, and this gets to your question, why are we prioritizing this approach. The benefit of it, we believe it can be Q3 week or Q6 week. So it has flexibility of dosing. The speed with which the KEYTRUDA disperses under the skin is faster with the hyaluronidase because it allows basically what hyaluronic acid does it breaks down. Hyaluronic acid is that is what actually allows you to the structure of your skin. And what hyaluronidase does is it temporarily breaks down that skin structure. And it allows fluid to flow under your skin. That's why you can disperse a lot more fluid in combination with hyaluronidase through subcu. So it has faster dispersion. And it has flexibility. That's why we're prioritizing that one over the other form, but we're moving both forward because you don't know what ultimately where the science is going to go. But we are prioritizing because we see the clinical benefit better for the hyaluronidase forum. But I think important most importantly is this is an opportunity to bring real value and in turn, continue our leadership in oncology well beyond 2028. Right. And as part of the strategy to advance in adjuvant, there's a specific goal by 2025 of having 25% in KEYTRUDA revenues. How are we tracking? Yes, we're probably, I would say on or ahead of schedule. If you look for instance, probably the three big ones we have right now adjuvant renal cell carcinoma, doing extremely well both the United States and starting now. It was later and it's launched in Europe doing well in Europe and doing actually starting to do quite well in Asia. Adjuvant melanoma continuing to do extremely well. Adjuvant triple negative breast cancer, which -- which is adjuvant neoadjuvant in 2022 in the United States, unbelievable. The uptake, much bigger and better than we expected. And we're starting to see that launching in Europe good results in some of the early markets there. So all in all, we're everything's moving, we feel very good that we're going to achieve that goal. Another key pillar, GARDASIL, demand. You set out an objective 2030 doubling the revenues you posted in 2021. The push pull there is that you have to have the manufacturing of the product as well. How are we tracking there, your confidence in being able to, meet that demand through your supply manufacturers? Yes, we are very confident. So as you recall, we have two new bulk manufacturing plants coming online in 2023. Those are moving. Those will be phased up. Their capacity will phase up through 2025. By 2025, we will be unconstrained to meet the demand we see. Between now and then we continue to expect to see growth, because of the fact we have been driving higher than expected productivity through our existing assets. Got it. And touch upon something against sotatercept, you highlighted really we have some more data coming through. But the actual read out of the phase 3 data that you announced, STELLAR, that details, something that you want to amplify here in terms of the timeline, I think that was a 2023. Yes, so important. Thank you for raising that. We are going to, obviously we top line that we're going to give the detailed data and actually we've decided we're going to present that at ACC. You're also going to see the Phase II data for our oral PCSK9 at ACC in March both of those. And then we are going to have an investor conference to help people understand why are we so excited about both of those as we move forward. Got it. So we're putting New Orleans on our calendars for early March. Touch quickly on LAGEVRIO transition this year into an anticipated commercial market there. Do you see this as something that could be a meaningful contributor for Merck beyond 2023 and any comments about the pricing dynamic as we switch to commercial? Sure. As we look at it, one I think LAGEVRIO has been such an important addition to the armamentarium to address COVID. Obviously, there's a lot of patients with drug-drug interactions. A lot of the comorbidities, especially as you look at elderly patients, who, frankly are contraindicated for the PAXLOVID product. So we continue to see good uptake, as we address that population. But frankly, much better outside the United States and inside the United States, very strong growth across Asia, in Japan, and Australia. So, it is continuing to be something we were focused on. It continues to be primarily under the emergency use authorization. In most markets, it is commercial, for instance, in Japan. But in many markets, it's still under emergency use. There is an opportunity. You might have just seen, we just actually got approval under a conditional approval similar to a U.S. emergency use, if you want to think of it that way. They call it a conditional approval in China. That came just in the last couple of weeks. So there's an opportunity there. How big, we're going to have to wait and see. I mean, clearly, LAGEVRIO is not going to be what it was in 2022, we have to see how the pandemic plays itself out what happens with the EMA approval, what happens with U.S. moving to a commercial launch, as you mentioned. So a lot of things have to play out. I wouldn't just to be clear, not like it was in 2022. But as an important tool for patient’s long term, it's something we're continuing to investigate. And we're actually doing a study now looking at use of LAGEVRIO in RSV because the mechanism by which it works actually works beyond just COVID. It works across any RNA-based respiratory virus. So you can think of the old, the old SARS, MERS, that works in all of those, and we believe it will work in RSP. So we're doing those studies. Great. In our last 2 or 3 minutes, 2 quick hits. Margins, you have the 2025 articulated goal of 43% target. Obviously, there's going to be some benefit from the roll-out of certain royalties for products KEYTRUDA, and GARDASIL as well as can you talk a little bit about the contribution relatively speaking of the roll-off versus product mix, versus any just OpEx level? I mean, the biggest drivers are mix and obviously, the royalties coming off in 2024. But the operating expense synergies are part of it. As we look at it, we are continuing to be confident, we're going to achieve that goal of being in excess of 43% in 2025. So nothing's changed in our commitment. The one thing I will say to you is, I am very focused on making sure we're making the appropriate investments in the business. So we are going to continue to invest in R&D and make sure that as we see the pipeline of opportunities, I just mentioned, several Phase IIIs were starting in, in 2023, that weren't planned for if we talked a year ago, those take money. So we're going to invest behind them. Hopefully, that's what you all want us to do, because it means we're investing for future growth. So we're going to invest in R&D. We’re committed to hitting the margin targets and confident in it. But I want to make sure that no one's taking this as we're trying to rob the business to drive margin. The businesses driving the margin, not us trying to pull back on spend to do it. And then last question, big picture very relevant for everybody in the industry here. IRA became law. Now we have questions about implementation. We're going to learn a lot, presumably, before September 1, what would you and Merck most like to see clarified? Can you name a couple of things at the top of your list? Yes, I mean, if you kind of just think through it, there's a lot of areas that are important to understand, how will the drugs be classified and selected? It’s not yet clear how there's going to be racked -- ranked, if you will, and stacked? And what will be the determinants? So for instance, is it going to be gross or net pricing? Those are important things. We need to understand that. How the biosimilar exceptions will work. We need to understand that the type of data they're going to use to make the assessments, how will that work? What when they say they want costing data, are they going to understand that it's not just the cost of the drug you're launching, it's the cost of all the drugs that failed, as well. How do we think about that? So those are some of the key areas that we're very focused on? How will they set maximum fair price? What does that actually mean? So those are some things that we're obviously as an industry, we're very engaged in discussions with HSS or HHS. And we're going to continue to do that. And but, my focus is making sure as we think about business development, as we think about our own pipeline, that we factor this in and influences the decisions we make because be clear, I do believe that's going to impact R&D And I don't think it's going to change whether we invest is going to change how you think about strategically bringing assets forward. I think it will change the way we assess assets in the business development context, because you're going to have to understand that. I can tell you with Imago, the deal we did recently, it factored into our thinking. I will tell you that case, it actually fortunately, is hits a rare disease exception for what is the major indication we're coming out with probably first. So it's in there, but it was in our valuation, it was in our diligence, and it's how we thought about the strategy. So it is affecting what we're doing today. And hopefully, over time, people recognize the unintended consequence on this on hurting innovation, ultimately, hurting patients is my concern. I don't think this was fully understood. And as an industry, we're trying to educate. And if we had more time, we could talk about it. But that's, that's something that I think you're going to see a lot of dialogue and dynamic about in the industry as we move into 2023. Excellent. I have to say, I'm so struck by how robust and energetic you are, as we enter this period in 2023. You clearly seem to be very comfortable in your own skin in this role. And we look forward to another sexy and robust performance for the stock in 2023.
EarningCall_1404
Good morning. My name is Todd, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fourth Quarter and Full Year 2022 Discover Financial Services 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. Thanks, Todd, and good morning, everyone, and welcome to today's call. I'll begin on Slide 2 of the earnings presentation, which you can find in the financial section of our Investor Relations website, investorrelations.discover.com. Our discussion today contains certain forward-looking statements that are subject to risks and uncertainties that may cause actual results to differ materially. Please refer to our notices regarding forward-looking statements that appear in the fourth quarter earnings press release and presentation. On our call today will include remarks from our CEO, Roger Hochschild; and John Greene, our Chief Financial Officer. After we conclude our formal comments, there will be time for a question-and-answer session. During the Q&A session, you'll be permitted to ask one question followed by one follow-up question. After your follow-up questions, please return to the queue. Thanks, Eric, and thanks to our listeners for joining today's call. I want to begin by reviewing the highlights and key metrics for the year, and then John will take you through the details of our fourth quarter results and our perspectives on 2023. I'm very pleased to say that 2022 was the second strongest year for earnings in our company's history. We reported net income of $1 billion or $3.77 per share for the fourth quarter and $4.4 billion or $15.50 per share for the full year. This was accomplished against a fluid and unusual macroeconomic and monetary policy backdrop and I want to thank the entire Discover team for their solid execution. This performance gives us significant momentum going into 2023 and beyond. I want to give a few highlights that underscore these strong results. First, we grew new accounts by 23% and loan receivables by 20%. This demonstrates the appeal of our consumer value proposition and advancements in our consumer targeting and acquisition capabilities while maintaining our conservative approach to underwriting and credit management. We're also prudently investing for growth, including an acquisition and brand marketing, the continuing build-out of our data and analytic capabilities and increasing field personnel for both servicing and collections, all while achieving a 39% efficiency ratio. The combination of revenue expansion and disciplined cost management contributed to our 31% return on equity this past year and underscores the highly capital-generative nature of our business model. Over the course of 2022, we repurchased $2.4 billion in common stock and increased our dividend by over 20%, and we expect to sustain attractive levels of capital return to our shareholders into the future. As we look into 2023, we expect a less favorable macroeconomic backdrop. Nevertheless, we intend to maintain an appropriate level of investment in our organization. For example, we have several initiatives that will improve our digital marketing capabilities, and we anticipate the broad market launch for mass market cash-back debit product. And of course, we'll continue to invest in our brand and in account acquisition in a manner consistent with the environment. We're very aware of the climate in which we are operating. And should there be changes in economic conditions, we will adjust. Our model with its focus on prime lending and through-the-cycle underwriting has historically supported resilient returns through the economic cycle. These factors, combined with our earnings power, reserves and capital, underpin our strategy of being the leading consumer digital bank. Thank you, Roger, and good morning, everyone. I'll start with our financial summary results on Slide 4. The takeaway of the quarter is largely about strong asset growth and net interest margin expansion, partially offset by growth-based provisioning. Asset growth combined with a NIM rate improvement, increased revenue 7% sequentially and 27% year-over-year. Similar to last quarter, asset growth also drove an increase in our reserves of $313 million. This increase has our reserve coverage ratio relatively flat at 6.6%. In the prior year, we released $39 million of reserves. So while our reported net income was down 3% year-over-year, adjusting for the reserve change, our net income would have been 23% higher on a year-over-year basis. Let's review the details starting on Slide 5. Net interest income was up $584 million year-over-year or 24%. Our net interest margin expanded, benefiting from the higher prime rate partially offset by higher funding costs and increased promotional balances. NIM ended the quarter at 11.27%, up 46 basis points from the prior year and 22 basis points sequentially. For the full year, NIM was 11.04%, up 28 basis points from the prior year. Receivable growth was driven by card which increased 21% year-over-year, reflecting continued strong sales, new account growth and payment rate moderation. Sales increased 8% in the period, a deceleration from the 15% growth we experienced in the prior quarter and the 20% in the first half of the year. New card accounts grew by 17% from last year's fourth quarter. Similar to the prior quarter, the sales growth decline was mitigated by a decrease in the payment rate, which fell 150 basis points in the quarter. We expect payment rates to continue to decline through 2023, but at a more moderate pace. Turning to our non-card products. Organic student loans increased 4% as a result of peak season originations. Personal loans were up 15%. We continue to stay disciplined in our approach to marketing, underwriting and pricing of this product. Our attractive value proposition has positioned us well in the market that is experiencing strong consumer demand and some improvement in competitive conditions. In terms of funding mix, our customer deposit balances were up 10% year-over-year and 5% sequentially. Deposit pricing continues to be in line with what we expected in a rising rate environment. Recently, we have seen some moderation in the pace of pricing changes. Looking at other revenue on Slide 6. Non-interest income increased $212 million or 47%. This was partially due to a $138 million loss on our equity investments in the prior year quarter, compared to a $6 million loss this quarter. Adjusting for these, our non-interest income was up 14%. This increase was primarily driven by two items. First, loan fee income was up $51 million or 39%, driven by volume. And second, we had higher net discount and interchange revenue, which was up $23 million or 7% reflecting strong sales and a favorable sales mix, partially offset by higher rewards costs. Moving to expenses on Slide 7. Total operating expenses were up $183 million or 14% year-over-year and up 8% from the prior quarter. Compensation costs were up primarily due to increased headcount and wage inflation. Marketing expenses increased $42 million or 15% as we continue to prudently invest for growth in our card in consumer banking products. Premise and equipment expense was elevated this quarter due to a onetime write-off related to the exit of our Phoenix servicing location. Adjusting for this, premise and equipment would have been flat to the prior year quarter. With this recent action, we have resized or exited three of our four major call center locations, and we'll continue to evaluate our footprint going forward. Moving to credit performance on Slide 8. Total net charge-offs were 2.13%, 76 basis points higher than the prior year and up 42 basis points from the prior quarter. In the card portfolio, the net charge-off rate of 2.37% was 87 basis points higher than the prior year and 45 basis points higher sequentially. As expected, portfolio loss rates are normalizing, reflecting seasoning of new account vintages from the past two years, normalization of older vintages and mild deterioration and low credit bands, largely inflation-driven. These trends are within our expected risk tolerances and are consistent with our historical approach to underwriting and credit management. Among our core prime revolver segment, we don't see evidence of broader stress given the robust labor market. I'll cover our 2023 view in a moment. Turning to the discussions of our allowance on Slide 9. This quarter, we increased our allowance by $313 million driven by the increase in receivable balances. Our reserve rate declined slightly to 6.6%. Adjusting for the elevated level of transactor balances in the fourth quarter, our reserve rate would have been near sequentially flat. Under the CECL accounting standard, we are required to contemplate life of loan losses and adjust our reserve levels accordingly. For us, the changes to employment conditions pose the most significant risk to our forecast. For the year-end 2022 reserve, our baseline assumption was unemployment in 2023 between 4.5% and 6.5% and with alternative scenarios above 6%. Looking at Slide 10. Our common equity Tier 1 for the period was 13.3%. Our longer-term target remains at 10.5%. We expect to make progress against this target over the next four to six quarters. Yesterday, we announced a quarterly common dividend of $0.60 per share. And in the fourth quarter of 2022, we repurchased $602 million of common stock. Concluding on Slide 11 with our outlook. Momentum is strong, which should help to generate double-digit revenue growth and positive operating leverage. We expect end-of-period loan growth to be in the low double digits with average loan growth somewhat higher. This is driven by three factors: our prior year growth in new accounts moderation in the payment rate and sales volume trends. Through mid-January, sales are up 13%, but we expect deceleration to the high single digits over the course of the year. We expect net interest margin to be modestly higher than the full year 2022 levels. More specifically, we expect NIM to be above the fourth quarter levels in the first half of the year driven by continued loan re-pricing benefits and decline in the second half. We are looking for total operating expenses to increase less than 10%. Salary and benefit expense will increase due to hiring in the second half of 2022. Additionally, we expect marketing to be above our full year 2022 level. We expect net charge-offs will average between 3.5% and 3.9% for the full year. The low end of the range is more in line with our base case, while the high end is more consistent with a weaker employment scenario. Lastly, we have $2.8 billion of remaining capacity under the $4.2 billion share repurchase program that expires in June of this year. We expect to repurchase around $2.2 billion of shares in the first half of 2023. We'll provide an update on future share repurchase authorizations after we complete our stress testing process and review recommendations with our Board. In summary, receivable growth continued to benefit from new account acquisition, payment rate moderation and positive sales. NIM continues to benefit from prime rate increases with funding costs consistent with expectations and credit is performing in line with our approach through-the-cycle underwriting process and conservative credit management. Our perspective for 2023 reflect our focus on advancing our strategic priorities generating high returns and capital while remaining disciplined in our credit and expense management. Great. And John, thanks for kind of outlining the parameters of the range of expected credit loss. But could you talk a little bit about the past kind of from here to getting to the 3.5%? Like what either has to happen that's bad or not happen, that's good. And at what points along that way, would you know whether that 3.5% base case is too high or too low? Yes. Great. Yes. Thanks for the question, Moshe. So the range is some unlocked, right? 3.5% to 3.9% for '23. And -- we certainly have a great deal of visibility through the first six months of the year through a roll rate methodology. Post six months, so in the second half of the year, we use our analytical models which anticipate a number of different possible outcomes but used as historical data that's been tested significantly to make a projection of what we expect to happen. So as we get through the first quarter, we'll be able to see what's happening with our roll rates in terms of is it a roll to one bucket and the roll to two bucket, consistent with our expectations on the base case on the reserve. Beyond that, we'll certainly look at the macro environment and what's happening with unemployment levels and the overall job market. That will give us some perspective. And then an important component of this, and I know there was some questions in terms of the step-up from where we ended '22 to where we're projecting '23. We have fairly significant vintages that are going through the normal seasoning process right now. So for example, our end-of-period card portfolio, so last year 12/31 to this year 12/31 increased by $15.7 billion. And if you think about kind of a maturity cycle of a credit card, typically within the first year to two years, you hit peak losses. So that is some of what we're expecting here, and therefore, the guidance that we've provided. We do expect that in a stable macroeconomic environment, in the second half of the year, we should see this slope of the curve begin to bend down a little bit with perhaps top losses coming through in '24 and then returning down. So overall, what we're seeing here is just a strong portfolio, very significant vintages that came through in '21 and '22 that are seasoning at levels that were -- that are completely within our expectation of total return thresholds. And then, we'll see the overall portfolio normalized. So hopefully, that provides some clarity on both the trajectory as well as what we're seeing in the portfolio. Perfect. And just as a follow-up, the reserve rate was down. You mentioned that was largely a result of transactor balances. But I guess even with that, it wasn't up. And so when you think about that, kind of how do you -- I mean, how should we think -- it doesn't feel like you're anticipating a deteriorating environment if you're keeping your reserve certainly no worse than flat. And how do we think about that going through '23 as well? Yes, great question. And they're connected, so happy to cover them in the same set. So CECL reflects life of loan losses as we all know, right? And so, what drives that is the portfolio performance and the -- our view of the macroeconomic environment today and going forward. And we haven't had any substantial changes to the macroeconomic environment. And essentially, the portfolio is performing within our expected ranges of outcomes. So, as we look at the fourth quarter receivable balances in the aggregate, and the portfolio performance, a stable macro, we felt most appropriate reserve levels would be fairly consistent with what we did in the third quarter. And essentially, without taking you through a ton of detail that the teams spend weeks and weeks working through, that's essentially how we arrive at the answer. Maybe just a follow-up question to the credit question is Moshe asked. John, you talked about the seasoning. Is there any way to parse apart the impact of seasoning in your range versus the actual degradation as a result of just the deteriorating delinquencies on a base case? And then you mentioned sort of the slope of the curve decelerates, I think you said in the second half, but I just want to make sure to understand sort of how the seasoning will impact us for the next two years. Does it still weigh in on you in the first half of 2024? Yes. So in terms of the impact of the vintages, I explicitly called out the card vintage in 2022, so the $15.7 billion to give the folks that are listening here, a place to anchor on in terms of thinking about the vintage and then you can run out peak losses for our portfolio in terms of what typically happens after a significant vintage and in a stable macro. So that should help you at least in terms of the thinking in terms of the vintage. As we think about this year, we gave that range of 3.5% to 3.9% on the loan base -- on the average loan base. So you should think about the ultimate kind of range here. It will depend first on the macro. Second, we'll continue to give updates in each of the quarters in terms of what we're seeing. But ultimately, we expect this vintage will mature in 2024. And then, we should see in a stable macro, the curve not only slope pending, but actually inverting slightly. Okay. Follow-up question on loan growth. Obviously, you mentioned the strong growth driving the seasoning, but you guys are still expecting double-digit growth in the face of maybe a tougher economic backdrop. What gives you the comfort here? Maybe Roger, speaking to the growth in the past, and I know every cycle takes on a different complexion. What are you guys looking at that makes you comfortable to grow here? Because that's a question I get quite a bit from investors. Yes. Good question, Sanjay. I think you've seen us operate this business through multiple cycles and the disciplined approach we take both in good times as well as in bad. And frequently, the accounts that you put on during a challenging economic time, perform extraordinarily well, and you can see very good cost per account as competitors pull back. So, we have been pretty clear that starting in the back half of last year, we started tightening credit standards, and you can expect us to continue to look at that and adjust according to economic conditions, both for new accounts as well as the portfolio. Nevertheless, we're seeing great returns on the marketing investments we're putting out there. And so, that's what gives us the confidence to keep investing in growth. Not to beat the dead horse, but maybe just one more question on the kind of the provisioning and the credit. John, I think you kind of detailed the unemployment assumptions. I think they were kind of in the 4.5% to 6% range with maybe somewhere making the 5% range, kind of the middle of the fairway. Just maybe can you tell us what's the sensitivity for the -- either the charge-offs or the ALL at say unemployment moves to level like 100 basis points higher than that. Yes. So in our kind of primary case here, we assumed a 100 basis points increase in unemployment. Now that that was specific to our charge-off forecast. In terms of kind of reserve levels, we actually used a composite of multiple scenarios. The more heavily weighted scenario reflected a loss rate of 4.5% and then going up all the way to 6%. So, I'm feeling actually like we're down the middle here in terms of appropriateness in terms of overall reserve levels and more specificity in terms of sensitivity. I don't think that would be a service given if we're seeing unemployment kind of creep up in that sort of matter or that sort of quantum that would indicate that the macro environment has changed, and we have to change our view on that, which could change our perspectives on life of loan losses. Okay. That's helpful. And then you gave annual guidance with NIM, and it sounds like maybe an elevated NIM in the first part of the year coming down second, what are the drivers of that with respect to the yield and the cost of capital? Yes. Yes. So I'm going to run through the primary drivers. So first would be the Fed rate changes in the second half of '22 as well as what we've anticipated either two or three increases in 2023. Second impact is the yield on our investments, which is improving with the increase in the rate environment. And then, the third piece has been some pricing actions we took in the consumer banking products. So, think about the non-card products. So offsetting that would be kind of the cost of funding. So DTC and external funding costs have increased. And then we're also anticipating an impact from credit, all of which the net of those gives us a high level of confidence that certainly, we're going to see peak NIM in the first quarter and then stepping down from there through 2023. I have one more credit question for you. I know you don't generally give out guidance more than one year out, but I think some of the commentary around the charge-off guidance has some implications for 2024. I just wanted to try and clarify I mean if you look at the guidance range, it seems to imply you kind of exit 2023 at a charge-off rate at 4% to 4.5%. I think, John, you indicated 2024 is kind of a peak year? Should we expect -- is it reasonable to assume that that's implying kind of a charge-off rate north of 4% for 2024? Yes. So you were right on your call here. We gave a range for 2023 of 3.5% to 3.9%. I talked about the curve and what we think will happen to the curve and the slope of that. So, Mark, as a matter of prudence, I think that's probably as far as I'm going to go here. Maybe a slightly different way to address this question is you perhaps could give us some color on where you have seen your fully seasoned vintages peak in terms of net charge-off rates and around what kind of month within the seasoning path that happens in a range of months that would be helpful to understand. Yes. So typically, we'll see it around 18 months. And it varies based on credit quality. So, the highest credit quality. So, I think FICO would typically peak a little later. And then the weaker, I'll say, the weaker credits typically peak a little bit earlier. But on average, I think, about 18 months or so. And the level that you've been seeing, it would be helpful to understand how historically, the vintages that you want to write to are trajecting in terms of peak. And maybe if you could comp 2022 vintage in 2021, what you're seeing there would be helpful? Yes. So -- the first part of that answer would be it would depend on the vintage. So if you go back to our 2020 vintage and remember, there's COVID, right, we were locked down. We ceased underwriting kind of the near prime and lower prime and concentrated on upper prime that vintage will season at a peak loss level below what Discover historically has done. If you look at '21, '22, we were essentially back to an underwriting standard consistent with history. And you can use that information to get some level of comfort around what can be expected in '24 on this vintage. Okay. Because you're basically saying '22 is a normal -- is exhibiting behavior that is more normal pre-COVID type of vintages? It is. Yes. Yes. The one difference that I think is important for folks to codify in their minds is that we're coming off an abnormally low base, right? So the entire portfolio is normalizing. We've talked about that consistently actually, since the beginning of last year that we thought the portfolio was normalizing. And what you're seeing here in the 2023 guidance is essentially the portfolio normalizing. Right. And this is -- I know we're talking about card, but is this the same kind of expectation across the other asset classes as well, student and personnel? Yes. Although what we're seeing in personal loans is, again, loss rates below historical norms. Payment rate is beginning to normalize. And we had talked about the fact that we perhaps overcorrected on that product in terms of underwriting, in terms of the pullback. We pulled back significantly. So I expect some seasoning and normalization there. But again, we're very, very confident about the loss performance of that product. We understand where it is on the payment priorities for folks. So we're going to be mindful of the economy on that. And student loans, yes, that's normalizing. We did have and likely we'll have a little bit of impact when we see the full impact of the student debtors on the government programs having to pay back loans, but it's underwritten to a high standard. 80-plus percent have cosigners. So, we feel very comfortable about that product as well. Look, this is an interesting milestone where the reserve rate is 658 basis points. It basically is apples-to-apples seasonality versus CECL day one and up 50 basis points. I'm curious when we think about your economic outlook and how you build a CECL reserve where you compare to CECL day one on a like-for-like basis, would you build the same allowance? Or have you made adjustments and then compare your economic outlooks in each of those points in time, please? Yes. So good question, Rick. So we've referenced CECL day one in the past, but I'd like to remind folks, day one was first time we rolled this new standard out. We were using new models. They've been tested extensively. And the macros were late cycle with higher unemployment levels. So as we look at kind of where we are today or as of the fourth quarter, right, 6.58 in terms of total loss reserve rate. That seems appropriate based on kind of what we're seeing in the macros and how the portfolio is performing. So, do we specifically reference day one only from the standpoint of where it was back on January 1, 2020, to where it is today, but we don't use that as a decision point whatsoever. John understood. I'm more curious that if you like were you've described that the models have evolved. And I think that, that's fair, and I think everybody appreciates that. What I'm asking is, on a like-for-like basis, would -- do you think that reserve rates are lower today using the same assumptions as you refine them versus CECL day one? Yes. No, no, they're not lower. We're looking at the portfolio performance. It's performed extraordinarily well. We're seeing a bit of seasoning now, as you would expect in this type of product. And the macros are contemplating a minimum level of increase in unemployment of at least 0.5% and more likely 1%. So what you're seeing here is a CECL reserve for the quarter that reflects those macros. Many -- some commentary, Roger, on the competitive environment for rewards. I mean, you've seen very strong growth out of a number of players in the industry, including yourselves. Can you -- are you seeing more competition? Where are you seeing more competition, more people getting more aggressive, if you would? Yes. Thanks Bob. It remains, I would say, intensely competitive. But as you've seen from the growth and especially the performance in new accounts, our value proposition is competing well. And again, I want to give credit to some of the advancements on the analytics that let us sort of personalize the marketing messages across different channels. I guess where competition has lightened a bit is in the personal loan space. I think there are a lot of non-bank funded folks there who may have some challenges on the other side of the balance sheet. And obviously, one big player who had been active is pulling out. On the deposit side, I would see there, I think you're starting to see the gap between the direct banks, the branch banks really get wide enough that you're seeing flows to the direct system, right? It's now at 3.3% for a savings rate. It's now a lot more worth your money. So again, really excited about how our products are competing across every segment. And so that's part of why we're optimistic going into 2023. What new products, I mean your cash-back debit is something that you've talked about? What new products are you most excited about? You're highlighting probably the big launch for next year, which will be the re-launch of cash-back debit and we hope to be doing some mass-market advertising of that. Beyond that, I really believe we have the right product set. We're seeing great demand, for example, on the home equity side, given how rates have moved and the lack of cash-out refi. So I think part of how we keep our costs as low as they are, is a very simple, lean operating model. So I wouldn't expect anything other than the re-launch of the cash-back debit and we'll put a lot of weight behind that. Back to the credit topic, anything about the charge-off guidance that baked into your guidance, that is a surprise at all in terms of what you're observing. I know you talked about the seasoning and the vintages and it sounds like there's nothing there that really surprised you. But I'm wondering, anything about the credit migration within the vintages, within the portfolio in the past dues and/or customer behavior that surprised you that led to the increase in the charge-off guidance that seems to be well above where The Street was expecting? Yes. Thanks, John. Actually, no surprises in the portfolio performance whatsoever, and I want to reiterate that. And that's essentially why the reserve rate is flat, right? So, they are connected. So what that says is that charge-off guidance was essentially contemplated in the reserving of life of loan losses. So, we feel very good about that and there is consistency. I did talk about in my prepared remarks that the lowest end of the credit spectrum that we have in our portfolio. So some near-prime and some folks without FICO scores or those who fell below 660 are certainly feeling the impact from inflation. But internally, we completely anticipated that we had run some analysis on inflation shocks and what it would do to some of the card members, and it's performing essentially where we thought it would come out. So I'm actually quite pleased about that. The other important thing that I want to make sure that the audience here is I think what 2022 did for us is it increased the earnings power of the firm. And there's a lot of focus from these questions on kind of the charge-off and peak good assets consistent with what we've done historically. So loans increased $18 billion. So, there's going to be some seasoning, but overall, the earnings power of the firm has increased as a result of great execution by our teams. Okay. That's helpful. And then, again, just -- I know this gets to CECL and the whole spirit of it. But given your commentary and that you just indicated reserve flat, so if the macro outlook progresses within your scenarios and the loss migration progresses as you described here into 2024 of this 2022 vintage, and no other surprises elsewhere, then would you expect accordingly that the reserve at 660 would generally remain around that level in that case? Or could there be incremental upside to the reserve, assuming that macro backdrop remains as they're within the scenario bands. Yes. So, there's -- I appreciate the question. A lot of assumptions in there, but as you laid out, I would expect the overall reserve rates to be relatively close to kind of where they are today. First, I wanted to ask if you could give us a sense of what kind of delinquency rates you'd expect based on that 3.5% to 3.9% NCR rate outlook? Yes. I mean we don't typically forecast the delinquency rates. You would -- what I suggest you do is take a look at the trust data and the relative difference between the trust data historically and where the total company is coming out, that will give some insights. And then also, the trends in delinquencies typically are pretty consistent, right? You can go point to point to point. And then I've given some views in terms of where we see the slope starting to flatten and then perhaps spend. So, I'd use that information in order to -- if you're interested in calculating overall delinquency rates for firm. Okay. That's helpful. I guess just the spirit of the question was, there isn't anything unique happening with that increase in charge-offs that would lead to a breakdown between the historical relationship that exists between delinquencies and charge-offs. In other words, the sharp increase that you're expecting in delinquencies -- or sorry, in charge-offs, it would be reasonable to expect sort of a commensurate sharp increase in delinquencies as the data start to come through? Yes, there obviously, a relationship there, certainly. Although remember, you should have -- you should take into account the kind of the vintage impact and what I'll say normal seasoning, right? So, there's $18 billion of incremental loans. Some of those are just going to perform extremely well and a small percentage will season, out as we typically see. So, I would consider that in the analysis, but nothing at it. There should be no substantial break. Okay. And my follow-up is, if I might have missed this, but why did an increase in early-stage delinquencies drive higher credit card and zero rates this quarter. Is my initial thought was that early stage delinquencies would have to flow through the various delinquency buckets before charging off? So what was it following how that early stage increase this quarter impacted NCOs? Just a clarification there would be great. Yes. Yes. Well, there's a couple of different components, right? There is -- there's a bankruptcy bucket. There's a non-bankruptcy bucket that just flows through the buckets. And then there's also the recovery element. So if you put those three together, sometimes the bankruptcy bucket is it will pop in a particular quarter, depending on flow of work in the court system and the non-bankruptcy just flows quarter-over-quarter. So, I would certainly look at this quarter, prior quarter and what comes out in the first quarter, and that will be the insights you're looking for. I wanted to just talk a little bit more about credit. So specifically, I think you mentioned a little bit of mild deterioration in credit among the lower bands. Does your guidance contemplate that stress in your prime core revolver portfolio at all as unemployment increases, I guess said differently, what I'm trying to understand is, do you think we go from credit formalization to deterioration for DFS overall? Or is it just normalization with just the vintage seasoning impacts that we've been talking about? Yes. Thank you. It's the latter. It is normalization and seasoning, which we contemplated fully in both our kind of origination strategy, our reserving strategy and obviously in the guidance we're providing. Yes. And maybe just to clarify, the lowest income segments which are a pretty small portion of our base are the ones that get additional pressure from inflation, right? By and large, a prime book can adjust. They trade down, they readjust their pattern. So I think John was referring to incremental stress there. But there's no reason to believe that the vast majority of our portfolio will be driven by the traditional drivers of losses, which is charge-offs -- I'm sorry, which is unemployment. Got it. And then, I did want to offer maybe a little bit of a big picture question, just longer term. I think -- we appreciate that you have added a lot of business and increase the earnings power because some of these assets will obviously last a long time past and into seasoning. But the portfolio has changed a lot and your guidance for the next year and it sounds like potentially even '24 is a little bit above where credit losses have been running. So maybe just remind us, what is the normal loss rate for DFS or for the card portfolio or something like that? Maybe give us a range. Just trying to understand where a typical portfolio settles out? Is it in that 3%, low 3% range where does that settle up? Yes. Thanks, Mihir. So -- we've been asked that question over the years many, many times. And what I typically refer people back to is, if you take a look at the details of the kind of the charge-off history, you can go back through 2008. And see kind of quarter-over-quarter what's happening on the charge-off front, you can discern kind of normalized charge-off rate from that and then make adjustments for economic periods or kind of vintage-based seasoning. And in regards to your employment forecast and your base assumptions, you're pretty clear that the low end, the 3.5% assumes the 4.5% to 5% unemployment rate. But can you help us understand or just confirm that the -- is it the 3.9% higher end of the range, implying a 6% unemployment rate or some other scenario out there within your expectations? Yes. So the high end does not weight the 6% entirely. It actually could reflect a scenario with unemployment is actually higher than the 6%, but it would depend on the depth of it and kind of what industry. So, there's multiple scenarios in there. So, the guidance I provided in terms of 4.5% or over 6% is intended to kind of get the kind of the meat of the scenarios that were contemplated and weighted. Okay. And then with your baseline assumption of 4.5% to 5%, is that something that we make our way to throughout the year and then maintain that level or something where you expected to peak there and then startly drift lower? Can you dig in a little bit more on the credit card spend growth rate and kind of what you're seeing in terms of any pattern changes. I think the last update through November showed a little bit of a step-down in the growth rate. And can you talk about December and I think maybe you touched on January? Yes. I'll start. January is off to a very strong start. So, we're seeing about a 13% year-over-year growth in sales, and again, reflects the new accounts we put on last year, but also, again, for those who aren't employed a robust environment. We have been seeing increases in the day-to-day category commensurate with inflation and so more spending shifting there. And a lot of what you heard from retailers in terms of softness around home improvement, and hard goods, but a lot of that was just, I think, some of the challenging comparisons to really robust levels from before. So, overall, I'd say, stable, but we're certainly encouraged by what we're seeing so far in January. On the marketing outlook, you had indicated that you expect to spend more than 2022 levels, which obviously was a very strong acquisition year for you. What's the thought process there in terms of expecting to increase spend after such a strong year? Yes, great question. And you know what, I'm going to hit kind of give an overview on expenses and now I'll specifically talk about kind of marketing and our thinking there. So, we said overall expenses would increase less than 10%. So, what that contemplates is a double-digit increase in marketing and single digits for the non-marketing spend. And what that reflects is, we continue to see opportunities to acquire profitable new accounts that are consistent with what we do. So that -- in that prime revolver credit card. We also are intending to spend some money on the launch of the debit checking product. So that will include dollars for new accounts as well as advertising to bring awareness to the product. And then, it's important to also kind of have a view on the marketing in that this is our guidance. If we see the macroeconomic environment change or we don't see ample opportunity to spend this money wisely then we will make calls in terms of the level of spend, and it could be less than what's -- what we've guided to. But overall, we're very, very pleased with kind of our targeting and the effectiveness of the marketing and gave us confidence to continue to increase that. And then on the personal loan side, you had indicated that it's -- it's clear that it's performing better than historically. With respect to the guidance, does the personal loan net charge-off rate, is that expected to go as high as credit cards in 2023? Or are you still expecting it to be somewhat better? Yes. I'm going to stick at the top level of the guidance we provided. And then, we give details by product in the supplement. I would use that information and impute kind of the charge-off rate there. But again, product has been performing very, very well, loss rates significantly below kind of what's happening out in the industry. And it's a kind of a -- it's a prime customer set. So that should give a view of kind of at least a way to think about expectations for that product. So, I think we're going to conclude our call there. Any additional questions, please reach out to the IR team, and thanks very much for joining us this morning.
EarningCall_1405
Greetings. And welcome to the Engine Gaming and Media Fiscal First Quarter 2023 Conference Call. Please note this conference call is being recorded. Before we begin, I would like to caution listeners that comments made by management during this call may include forward-looking statements within the meaning of applicable securities laws. These statements involve material risks and uncertainties, and actual results could differ from those projected in any forward-looking statement due to numerous factors. For a description of these risks and uncertainties, please see Engine's fiscal financial statements and MD&A for the fiscal first quarter 2023 ended November 30, 2022 available on SEDAR and EDGAR. Important qualifications regarding forward-looking statements are also contained in Engine’s earnings release distributed early this afternoon and also available on SEDAR and in EDGAR. Furthermore, the content of this conference call contains time-sensitive information accurate only as of today, January 17, 2023. Engine undertakes no obligation to revise or otherwise update any statements to reflect events or circumstances after the date of this call. I would now like to turn the conference over to Mr. Lou Schwartz, Chief Executive Officer, and Tom Rogers, Executive Chairman of Engine Gaming and Media. Please go ahead. To begin, total revenue for the fiscal first quarter of 2023 was $10.3 million compared to $11.5 million in the fiscal fourth quarter of 2022. The decrease in total revenue was largely due to short-term headwinds impacting our advertising segment of the business driven by Google algorithm changes, which affected traffic to our largest legacy media client and was not a function of overall advertiser demand. We anticipate these headwinds to be short term and expect to gradually improve in the coming quarters. Despite these short term advertising headwinds, we continue to see heightened demand for our influencer marketing platform and data insights offerings for game publishers, agencies, and brands looking to drive revenue through targeted audiences, while managing influencer relationships at scale. For the fiscal first quarter of 2023, SaaS revenue remained relatively flat at $2.4 million due to the declines in legacy content management related SaaS revenues. Importantly, revenues from our influencer and data technology SaaS businesses are up 35% year-over-year, driven by the demand I just mentioned. This is a welcoming trend, heading into our merger with GameSquare, further supporting our merger transaction thesis of driving expanded revenue for game publishers and brands looking to reach youth audiences with a comprehensive set of creative capabilities that leverage our software platforms. We're also very excited by the recent accomplishments of our product and software development teams, delivering feature enhancements across all of our platforms that enable customers to efficiently analyze, find, activate, monetize, and report against hard to reach audiences. Whether it's managing communications and workflows with influencers at scale, analyzing billions of live streaming data records, or tracking and managing affiliate performance marketing payouts, our platforms continue to evolve to meet the needs of complex brand marketers and game publishers. During the quarter, we continued to make notable improvement in our near term goals of achieving a cash flow positive position. Importantly, adjusted EBITDA improved 32% sequentially to negative $2.7 million when compared to negative $4.0 million in the fiscal fourth quarter of 2022. When compared to the year ago quarter, adjusted EBITDA improved 17%. Evident in our sequential analysis of our adjusted EBITDA is our pathway to profitability and sustainable growth. Additionally, net loss improved by nearly $10 million to a net loss of $5.4 million compared to a net loss of $15.2 million in the fiscal fourth quarter of 2023 despite the restructuring charges related to discontinued operations. We believe in the company's growth trajectory and look forward to completing the recently announced merger with GameSquare, which Tom will speak to in a moment. Our platforms that are immersed in the gaming, social influencer and creator content spheres continue to benefit from the growing demand among marketers for the data and analytics we provide to enable marketers to better navigate those spaces. These businesses have become increasingly important to advertisers and sponsors desiring to reach younger demographics and are extremely complementary to the GameSquare offerings. Thanks, Lou. We indicated in our last earnings call six weeks ago that we have high confidence our strategic process would conclude with a great opportunity for the company. That certainly did occur in entering into a definitive merger agreement between Engine and GameSquare. Our stated goals of finding a strategic solution which would increase scale, catalyze further growth, and unleash both cost and revenue synergies are all realized through this transaction. We believe this merger provides strong potential returns for our shareholders by allowing Engine stockholders to participate in the value creation of the combined company. Since the transaction’s announcement, our stock price in fact has risen about 120%. The central thesis of the merger is that traditional media companies are no longer able to deliver millennial and Gen Z audiences at anywhere near the scale that they used to. Moreover, digital media companies are increasingly inhibited in their ability to target audiences because of the new privacy restrictions of the major tech platforms. This has had a particularly adverse consequence when it comes to targeting gaming audiences. The combined company can provide solutions to both of these major marketing problems. Moreover, the combined assets of the two companies not only will provide a solution, but one that has enormous audience scale behind it. Beyond the scale it will provide, the fact that the combined company operating an end-to-end one-stop shop approach to satisfying the needs of sponsors who want to reach youth audiences at scale, the company will provide a very efficient path to doing so that takes a great deal of friction out of the process where today's sponsors need to deal with multiple smaller companies. The ability for the combined company to engage a brand by what GameSquare brings to the table, one, providing an overall young audience focused campaign strategy; and two, providing content development and production capability; and three, being able to activate advertising, both through a publisher network and broad influencer channel and the substantial reach of a major esports team. Then add number four, that that reach can be amplified by the tech platforms that Engine brings to the table, in Stream Hatchet, Sideqik and Frankly, each of which uses data and analytics to enable navigating distribution more broadly across various live streaming gaming and content platforms and social media content creator sites and programmatic advertising network. And then lastly, five. The measurement and assessment analytics of the Engine assets enable further refinement and optimization of marketing campaigns to continually increase efficiency for advertisers and sponsors. Put all that together with the historical top line growth of each company and the progress each has made in moving toward cash breakeven this year and the combined company creates a powerful new entrant into a highly sought-after media sector, especially with the revenue and cost synergies to be realized. Moreover, taking the current combined market cap for the two companies, the two companies in our mind are priced now at deep discount to both marketing and gaming peers. We expect to close the deal during the first quarter of the calendar year. We appreciate investor support while we move toward closing the deal. Congrats on the successful completion of the strategic review process. Just a question on that deal. GameSquare and their eSports franchise Complexity, were both previously clients of Stream Hatchet and Sidekiq. I'm curious outside of those relationships, how much overlap there's historically been between the client bases of the two companies and how much opportunity is there for cross selling of the product bases of the respective companies to the other client bases I guess is the way of saying it? Well, there is not great overlap. But we've had enough experience with mutual clients to have a clear sense that many, many of the clients of each company are going to be able to take advantage of the offerings of both companies. So that, one, there isn't a great deal of overlap, which is great opportunity, but enough overlap to give us great confidence that the advertisers and sponsors of both companies will be able to take advantage of what the combined company has to offer. On the same topic, obviously, you've talked a lot about in the prepared remarks the top line sort of strategic rationale for the move. There's also the benefit of scale, with two public companies coming into one public company. Is there anything maybe not quantitative or qualitatively you can talk about the cost synergies you expect to realize once the deal is closed? And also, what are some of the steps necessary before the transaction is actually officially closed? I'll pick the latter part of that and, Lou, you could address the cost issue. In terms of the steps to close here, which, as I said, we hope to accomplish during the first calendar quarter, we need to get approval of the Toronto Venture Exchange. NASDAQ needs to approve the listing of the combined company where we'll need, of course, approval of both the Engine's and GameSquare's shareholders. And then, ultimately, there is final court approval, the Canadian court that ultimately puts the final stamp on the so-called plan of arrangement, which is what the term is for the merger agreement. There's some iterative steps in there as well, but for the most part, that's what needs to be accomplished before the deal closes. On the cost side, as we indicated at the time of the announcement, there's a number of different areas where we realized a cost efficiency. The most obvious, when you bring two public companies together, is the public company costs, the professional service fees, the listing fees, the audit fees, those are corporate costs that we are able to remove from one side of the ledger as we combine into one. Then the other is, as we bring these two businesses together, there's minimal overlap, as we indicated. Many of the GameSquare's sort of businesses are focused on creative services and agency-related services, whereas the Engine gaming sort of businesses are much more sort of technical and software sort of related. So, there's not a ton of efficiency there. But we are continuing to focus on integrating the various sort of business units where it's natural and obvious and we can realize additional sort of cost synergies. The area where we really get leverage is really on the top line where there's obvious commercial synergies that we realize by providing sort of brands on both sides, GameSquare and Engine with a much more sort of comprehensive set of capabilities. Congratulations on your upcoming merger. I was wondering if you can provide some more color on GameSquare. You say that it's an end-to-end solution. And I was just wondering if you can explain that a little bit. And then can you provide more details on what's unique about it relative to everything else that's out there? Well, in delivering an end-to-end solution, I outlined a number of those elements in my remarks. But the combined company's ability to be able to offer brands a strategic evaluation, content development and production, live experiences that are another way of bringing about connectivity to youth audiences, creator activations, amplification of that through a very broad influencer and advertising set of networks, combine that with the technology platforms that we provide in terms of analytics and optimization tools, and you really have the ability to bring a brand or sponsor from strategic development all the way through to activations within the very scaled reach that GameSquare already has and through our technology platforms, be able to navigate through other distribution paths to further enhance the connection to youth audiences at scale. So, that's one major way to look at how unique that is. Then you look at the areas where the combined company would touch on gaming, sports, music, various forms, other forms of media and youth culture and you get a wide range of content areas that youth audiences can be connected through. And then think further in terms of authenticity, which is obviously critical in terms of the value of the engagements that you're getting from those audience and just think about the headquarters of the combined company being embedded with the Dallas Cowboys' players facilities, which is also the home of the Complexity eSports team owned by the combined company. And you get that sports/eSports authenticity, I think, coming through by virtue of the company cultures. And the two companies, as indicated before, are already working with a wide range of premium advertising brands, across many categories, across gaming, across consumer packaged goods, across the media world, the food and beverage sector, the apparel sector, the hardware sector, and other industries, in connecting younger audiences at scale. So there's already deep experience across a broad range of sponsors, with the kind of needs that they have in being able to bring their messaging to a youth audience. So, you put all that together and we just don't see another peer company with a group that you and other analysts often point to when comparing companies that come close to being able to offer what we see the combined company being able to offer. You mentioned are creating a scale play to reach the and engage these young audiences. And I was wondering if you can just talk a little bit more about how you look at the eSports in terms of its scaled reach. And as you mentioned, traditional media outlets are challenged in delivering the millennials and Gen Z audiences. What are you seeing in terms of eSports that make it a valuable substitute? Well, I'm glad you touched on that because some think, to some extent, at least, that the bloom has come off the rose with respect to certain elements of the eSports world. And I think, in really assessing the value of eSports to the combined company, you need to define how you're looking to monetize eSports. Very important to point out, this isn't about consumer facing eSports tournaments and contests where the goal is to drive revenue through some kind of consumer fee payment. That isn't what the goals of this merger is about. We spent a lot of time measuring eSports. Obviously, GameSquare has an esports team that's highly noteworthy. This is about using the extensive reach of eSports as a vehicle for marketers to connect to younger audience. In the context of a marketing and advertising reach orientation, where as you say, it can easily be looked at as a substitute for what legacy media can no longer deliver in the way that it used to. And in that sense, eSports is also a way to attract more creator content and look at as a basis for catalyzing even more influencer connectivity, where the influencers of those world have terrific ability to connect and drive the consumption patterns of younger audiences. In that sense, it's a very important component of a youth marketing vehicle. It is one, though, I should say, of many other components of the entire combined merger enterprise that will be at work here. And just to give you some sense of the growth of eSports. Stream Hatchet, obviously, chronicles this all the time. And for the third quarter of 2022 compared to the third quarter of 2021 – the third quarter of 2022 being the latest report that Stream Hatchet put out, there was a growth from 480 million hours watched globally of eSports across various platforms. And that grew in the third quarter of 2022 to 673 million hours watched, a 40% increase in eSports hours watched globally. That just gives you some sense of what the magnitude is of the potential for using eSports as a vehicle, part of the overall assets that we have to connect youth audiences. Just one last question. You point to the progress you're making towards your expense reduction efforts. And I was just wondering if you can give us an update on your cost reduction improvements. I can take that one. As you know, this has been sort of a work in progress for us that began almost a year ago. And we're really proud of the progress that we've made. As you recall, our initial focus for expense reduction was the elimination of our B2C businesses in favor of our more predictable B2B SaaS businesses. And that cost cutting sort of mindset expanded to include corporate overhead and then greater focus on operational efficiencies across our business segments, which will continue to contribute to our goal of achieving profitability later this year, along with top line revenue growth. But as we announced our expenses in the fiscal quarter were $15.8 million, and that was an improvement of $6 million when compared to $21.8 million for last quarter. But the actual cash reduction was about $1.3 million quarter-over-quarter. So we're continuing to make good progress and remain confident in our ability to get to profitability later this year. Thank you. We've reached the end of our question-and-answer session. I'd like to turn the floor back over to Tom for any further or closing comments. Thank you very much. Thanks, everybody, for joining us this morning. And as I said, we appreciate the investor support while we move towards closing the merger agreement. Thanks again for joining us. 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.
EarningCall_1406
Thank you for standing by, and welcome to the Great Southern Bancorp's Fourth Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] As a reminder, today's program is being recorded. Thank you, Jonathan. Good afternoon and welcome. The purpose of this call is to discuss the company's results for the quarter ending December 31, 2022. Before we begin today, I need to remind you that during this call, we may make forward-looking statements about future events and financial performance. Please do not place undue reliance on any forward-looking statements, which speak only as of the date they are made. Please use our forward-looking statements disclosure in our fourth quarter 2022 earnings release for more information. President and CEO, Joe Turner; and Chief Financial Officer. Rex Copeland are on the phone -- are on the call with me today. All right. Thanks, Kelly. Good afternoon to everybody. We appreciate you joining us today for earnings call. Our fourth quarter results reflected another strong quarter for Great Southern. We benefited of course from rising market interest rates and our 2022 net income and earnings per share were exceptional. On a macro basis, 2023 appears to be a year that will be marked by a great deal of uncertainty. We're focused on ensuring that our company is positioned for this uncertainty as we move forward in light of the changing interest rate environment and other macro headwinds that are forecasted for 2023. As usual, I'll provide some brief remarks about the company's performance and then turn the call over to Rex Copeland, who will get into more detail on our financial results. Then of course, we'll open it up for questions. In the fourth quarter 2022, we earned $22.6 million or $1.84 per diluted common share, compared to $15.3 million or $1.14 per diluted common share in the same period in 2021. The 2021 period did include some large non-recurring interest -- non-interest expense items, which reduced our net income and EPS. We had a few significant income and expense items during the fourth quarter of '22 as well. First of all, Legal and Professional fees, we told you that for the remainder of 2022, and then probably the first-three quarters of 2023, we would be having between, the $21.1 million and $1.3 million of quarterly expense related to professional services for helping us with our conversion and we did have actually a little more than that $1.4 million of those expenses during the quarter. We had an investment sale loss of $168,000 during the quarter and we had an income tax adjustment, which reduced income tax expense by $1.1 million, although, we expect going forward our income tax expense or income tax rate will be more similar to what it's been in previous quarters. Our earnings ratios were all strong. Our return on assets was 1.58%, our return on equity was 17.34%, our net interest margin was 3.99% that improved from 3.37% in the year ago quarter and 3.96% in the third quarter of 2022. It does look like at least a couple more times in 2023, the Federal Reserve will raise interest rates that may help us slightly although, I think this late in the rate rising cycle, I think any benefit from rising interest rates it's going to be pretty muted. As far as loans go, from the end of '21, our loans grew almost $500 million, 12.5%. The growth slowed in the fourth quarter to about $10 million. Our pipeline of loan commitments was basically flat from the end of the third quarter to the end of the fourth quarter, but was up significantly from the beginning of the year. So, good lending volume although, probably flowing loan volume in the fourth quarter. Our credit quality metrics remained extremely strong, very low levels of non-performing assets, $3.7 million at the end of the year, loan delinquencies are very low. Our capital did pick up a little bit in the fourth quarter. Our TCE ratio went from 8.8% to 9.2%. We paid a 45th dividend in the quarter. Total dividends during the year of $1.56. And in addition, in our efforts to enhance shareholder value, we did repurchase about 1.04 million shares of our stock during 2022 at an average price of $59.25. I think our repurchase activity did slowdown in the fourth quarter maybe about 50,000 shares repurchased. Thank you, Joe. I will talk first little bit about net interest income and margin. Joe mentioned some of the highlights there and I'll just give a little bit more detail. Our net interest income for the fourth quarter of 2022 increased about $10.4 million or 23.5% compared to the previous year quarter, it was $54.6 million in fourth quarter '22 versus $44.2 million in the fourth quarter of 2021. And then, net interest income for the third quarter of '22 was $52.9 million, so we increased a bit from that as well. As Joe mentioned, increasing market interest rates and some loan growth throughout 2022 and some investment balances growing as well, contributed to the higher level of net interest income in '22. The net interest margin of 3.99% as we said earlier compared favorably to a year ago at 3.37% and then third quarter it was 3.96%. The average yield on loans increased about 98 basis points when you look at Q4 '22 versus Q4 2021. And then the rate on our interest-bearing deposits, the average rate on that increased about 89 basis points in that same timeframe, so looking back to the year ago quarter. And, again, margin expansion was really kind of based on the increasing market rates and also changes in the asset mix, where we had more cash and cash equivalents at the beginning of the year and changed those over into loans and investments throughout the year. As we've stated before and as you've seen through the numbers, generally a rising interest rate environment, particularly in the short-term rates should have a positive impact on net interest income as those are floating-rate loans repriced upwards. We anticipate this will still be the case if the Federal Reserve rate raises rates further. But like Joe mentioned, we think that perhaps we've obviously seen significant interest rate increases throughout 2022 and the expectation at this point at least is that we may have some more rate hikes, but not generally nearly to the magnitude that we saw in 2022. So we think that there may be some benefits there, but we also will have some time deposits that are going to mature and reprice higher that may offset some of that as we move through that throughout the first half of 2023 and beyond. As I mentioned, 2022 the assets shifted away from cash equivalents to loans. In the latter half of 2022, we also saw some changes somewhat in our deposit mix with non-time account balances trending lower and time deposit balances trending higher. The increased time deposits are generally a mix of shorter term retail within 12 month maturities and less -- some fixed rate broker deposits, which are maybe a little longer to little bit more intermediate-term they have some callable features and there's some variable rate broker deposits as well. So, and then from time-to-time, we also utilized generally overnight home loan bank borrowings. So just kind of to say 2022, again, supported by rising rates, loan growth. And as we said, 2023, we expect that our net interest income will remain solid, but assuming no rate cuts, but we also think that it may not grow tremendously even if the Fed raises by another 50 basis points or 75 basis points. We do have some deposits that will start to reprice as we head into 2023 here. And we also just a reminder, we do have a couple of interest rate swaps that were forward starting that are not impacting anything right now that will impact our numbers beginning I believe, in May of 2023. And based on where rates are today, we would be in a position where we would be making a net settlement payments to the counterparty so that will reduce our net interest income a bit on that. So those will change, obviously, as interest rates change, but they are tied to Prime and SOFR rate. So based on where they are today, we would have a payment that we would have owe on that. I'll move on to non-interest income. For the quarter, non-interest income was down about $1.5 million compared to the year ago quarter. Really the majority, almost all of that could be attributed to the reduced amount of gain on sale of our mortgage loans. Obviously 2020 and 2021, we had big years of mortgage origination of fixed rate loans, which we typically sell in the secondary market. 2022, obviously, rates -- once rates started moving higher after the first quarter that slowed down quite a bit, refinancing slowed down if not very much at all, and purchase was still going on but to probably a lesser extent than what we were seeing in the previous couple of years. So, those are some things that, that impacted the fourth quarter this year versus fourth quarter last year and really that's impacted the entire year of 2022 for the most part. One other thing I'll mention on non-interest income that it's not -- hasn't been real material at this point and we're not sure it's going to be a big thing it seems like it's a little bit of a headwind, but fairly minor relates to our point and sale income. There are some changes. We started seeing this in the latter half of 2022, seeing some of this change happening. There is some changes in the network settlement routing process due to some expiring agreements that we had and so there's different places now that merchants can route their transactions and some of those may provide a little smaller amount of fee revenue to us on those. And then also we noticed in the last half of the year of '22 as well that just a slight decline in overall debit card usage with our customer base. So we're looking to see if that's going to continue, we feel like perhaps that some of the debit card usage that we were seeing has shifted over to credit card usage with our customers and so we're monitoring that as well. Non-interest expense for the quarter, our non-interest expense decreased about $1.4 million compared to the prior year quarter. As Joe mentioned though, we had the biggest decrease was $2.7 million net decrease from a year ago in the legal audit and professional fees. Again, we had about $4.1 million kind of one-time fees related to our conversion activities in the fourth quarter last year. We had $1.4 million related to the conversion, but not the same type of activity, but related to that again this year. So, we did see a decline in the expense for that. However, we did see an increase in salary and employee benefits of about $1.4 million from the prior year same quarter, some of that's related just the normal merit increases, a lot of folks are in our company are -- they do their merit increases at the beginning of the year, there's others that are throughout the year. Some of those because of the job market, particularly in that kind of thing, some of those increases were maybe a little bit larger in 2022 than they had been in some previous years. Then also we did add during the year the Phoenix and Charlotte loan production offices and that added some expense to 2022's numbers that were not in 2021. The efficiency ratio for the fourth quarter was 55.13%, compared to 66.98% for the same quarter a year ago. Remember there was -- that extra expense in there a year ago and if you exclude that, the efficiency ratio would have been just a little over 57% in the fourth quarter of '21. So, just to conclude on non-interest expenses, as we saw in '22, while we remain in an environment with higher inflation that we've seen in quite some time, the salaries and benefit costs may continue to increase a bit due to the tight labor market and we've also got changes happening in various states minimum wage laws where we operate. And then again an annual merit increases, a lot of which happen at the beginning of the year. So as we especially move forward throughout 2023 with this core system conversion, we need to make sure that we retain our seasoned people to provide assistance in a lot of these roles. Talk a little bit provision for credit losses, we continued to have some loan growth and we recorded a provision expense. The net was about $0.8 million in the fourth quarter, $1 million of that was an expense related to our outstanding portfolio and about $159,000 was a net reduction in provision expense related to unfunded loan commitments. And then we had a negative provision of $1.7 million in the fourth quarter last year, $3 million negative provision on outstanding loan portfolio and the $1.3 million provision expense related to unfunded in that fourth quarter of 2021. Net charge-offs were $281,000 in the fourth quarter '22 compared to recoveries of $125,000 in the fourth quarter of 2021. For the full year, I think, our net charge-offs were around $274,000 or something like that. So, again, pretty low charge-off year. While we do have pretty low levels of problem assets and delinquencies, we are mindful of higher market interest rates and the uncertain economy as we do begin to go into 2023 year. Last thing I wanted to touch on is, income taxes. For the three months ended December 31, 2022, our effective tax rate was 16.6%. In the fourth quarter last year, it was 21.1%. Our effective tax rate is typically lower or at or below the Federal statutory rate of 21% due to some tax credits that we have some tax-exempt interest that we have and other things that produce that. Our tax expense and liability is also affected by the liabilities we have in various states where we operate and driven by the level of income or specific tax rates in those states. So those do tend to bump our overall tax rate up a little bit. So, Joe mentioned earlier, we had a bit of an unusual adjustment in the fourth quarter of 2022. So, when we finished up our Federal and various state income tax returns for the 2021 tax year in the fourth quarter of '22, the company updated its combined tax rate applied to deferred tax items and we also made some adjustments in our taxes receivable, payable balances related to some carryback claims that were put into place and filed in 2022. So those adjustments made a final reduction, we reduced our tax expense for $1.1 million in the fourth quarter. As Joe said, that's not something to expect all the time. We think our effective tax rates probably going to be somewhere in that around that 21% level, give or take a little bit on either side. But overall we think that going forward 21%, somewhere in that ballpark will be a good number to think about. That concludes the prepared remarks that we have, I think, today. So at this time, we'll turn it over for questions and ask our operator to once again reminding attendees how to queue in for questions. Hey, everyone. Good afternoon. Question on the margin. It sounds like the certainly some upward pressure on funding costs. So do you think the margin is topped out here at 3.99% or do you think there might be a little more opportunities for expansion before the flaps (ph) kick in? I'd say, it's pretty close to the topped out, so be my guest. I mean, obviously, when the swaps kick in, as Rex mentioned though well they get tick down. So, no I think it's kind of out topped out. Got you. And then on the -- just my back of the envelope numbers, maybe I'm off here but please direct me otherwise, I'm coming up with maybe 12 basis points of reduction to the margin on the swaps or am I calculating this wrong? So, that leaves $7.2 million and our margin was $220 million. That sounds -- now you are saying 12 basis points -- that probably is about right. Our interest-bearing assets are how much, Rex? Got you. All right. Thank you. And then Joe, just on your comment in the release about net interest income plateauing or possibly declining that sounds like the fourth quarter run rate, is that correct not the full year 2022 number. Yeah. And in the half of 2022, obviously, our net interest income was lower than it was in the second half, because rates didn't rise immediately in the year. And so we got a lot more benefit in the third and fourth quarters last year. So, that's what we're talking about compared to fourth quarter. Hey. Good afternoon, guys. Hope you're both doing well today. So just a quick question on loan growth. Can you just give a little perspective on kind of how you're feeling about your pipelines in the early part of this year and kind of what your expectations might be in the coming quarters for the like-for-like growth. Well, I mean I think -- I think, Damon, the thing to -- the first part of our loan growth comes from our un-funded construction commitments, which I think we’re like $1.44 billion or something at the end of the year. So, and that's substantially higher than they were at the end of the year, so that's going to continue to fund and that's going to be some that's going to be some loan growth now. I will tell you loan origination have definitely slowed down, I think what the Fed has done, at least as far as commercial real estate goes, there is not nearly as much activity as there was. So, that's probably a little bit more of an issue for as far as -- I mean I think what we could see is, is we could see the unfunded commitment line drop, because we're not booking new construction loans and adding to that unfunded commitment line, but we are going to be funding loans off the commitment line. But again, we don't forecast I mean you guys have to sort of come up with your own numbers, but I would say this, it's not going to be loan growth in year like we had in 2022. The other thing that you got to factor in, I mean, I do think payouts have slowed the projects are staying with us longer, which is positive thing. Got it. Okay. That's helpful. Thank you. And then with respect to credit in kind of trying to figure out the provision here, obviously very strong underlying credit trends minimal net charge-offs. You had a couple of quarters in the middle of 2022, where you had like $2.2 million and $3.3 million for 2Q and 3Q and then it kind of tailed off here in the fourth quarter. How do we kind of think about like where the reserve level is today at 1.39 and how are you viewing kind of the more macro picture and maybe they need to build reserves or do you feel like you're comfortable at this level? Well, I mean I think we're comfortable at this level if the economy were to take a turn, we would have to address that. But based on what we're seeing right now, we're comfortable. I think the provision -- the provisioning that you saw last in 2022 early on like the second and third quarter timeframe was a lot of based on loan growth that was going on. So we were adding to our reserves at that point and now we're -- like Joe said we didn't grow as much our outstanding balances in the fourth quarter, but we're looking at economic factors now as we kind of move forward into 2023 to see if it starts to look like recession. And if so how bad and how that might impact. Got it. Okay. And then, just to circle back on the margin and the impact of the swaps. Could you just repeat when do those -- I know you said they are forward swaps, but when do those kick in, in May or June? I believe it's -- May of '23, I believe is the first month that we would have a settlement on those. Okay. And if those were to happen like today, right? Then the margin would get hit by 12 basis points, based on the math that was being thrown around? Yeah. I think that's -- I think that's pretty close. I think when we calculated it then a few weeks ago, I think it was about 600,000 a month. Hope you're doing well. Just, Joe, maybe just one quick question on the buyback. You guys were obviously fairly active in 2022 and you announced a new plan, but you did slow the pace in the fourth quarter. How should we sort of think about buyback activity for '23? It sort of depends on the price. We obviously have been -- I mean, we bought at a higher price than where we're trading right now, so we kind of like it, we think it makes sense, I don't think will probably be -- may be quite as aggressive, certainly don't think it makes sense. Not as aggressive as we were in the -- during the full year 2022. So, we definitely still buyback makes sense and we feel like we're well capitalized and plenty able to handle it. It depends a little bit on what kind of turn the economy takes, obviously, too. So we got to factor that into. Just as far as you know, capital management, Joe any -- or Rex. Any other than the dividend, any other thoughts on sort of read redeploying our capital and so forth? Thank you. This does conclude the question-and-answer session of today's program. I'd like to hand the program back to Joe Turner for any further remarks. All right. Well, we appreciate everybody being on the call and we'll look forward to talking to you in April. Have a good day. Thank you. Thank you, ladies and gentlemen for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.
EarningCall_1407
Good day, and welcome to the Q4 and FY’22 Adobe Earnings Conference Call. Today's conference is being recorded. At this time, I’d like to turn the conference over to Jonathan Vaas, Vice President of Investor Relations. Please go ahead. With me on the call today are Shantanu Narayen, Adobe's Chairman and CEO; David Wadhwani, President of Digital Media; Anil Chakravarthy, President of Digital Experience; and Dan Durn, Executive Vice President and CFO. On this call, which is being recorded, we will discuss Adobe's fourth quarter and fiscal year 2022 financial results. You can find our press release as well as PDFs of our prepared remarks and financial results on Adobe's Investor Relations website. The information discussed on this call, including our financial targets and product plans, is as of today, December 15th, and contains forward-looking statements that involve risk, uncertainty and assumptions. Actual results may differ materially from those set forth in these statements. For a discussion of these risks, you should review the factors discussed in today's press release and in Adobe's SEC filings. On this call, we will discuss GAAP and non-GAAP financial measures. Our reported results include GAAP growth rates as well as constant currency rates and adjusted growth rates in constant currency that also account for an extra week in fiscal 2021. During this presentation, Adobe's executives will refer to constant currency and adjusted growth rates unless otherwise stated. Reconciliations between the two are available in our earnings release and on Adobe's Investor Relations website. 2022 was an exciting and eventful year for Adobe. We achieved record revenue of $17.61 billion, representing 15% year-over-year growth. GAAP earnings per share was $10.10 and non-GAAP earnings per share was $13.71. We delivered record operating cash flows with a focus on profitability. Our strong performance in the uncertain macroeconomic environment underscores the resilience of our business and the mission-critical role of our products in a digital-first world. Our strategy to unleash creativity for all, accelerate document productivity and power digital businesses is driving momentum across every geography and customer segment, making us one of the most innovative, diversified, and profitable software companies in the world. We continue to execute against our product roadmap, serve a vast customer universe from individuals to large enterprises and deliver strong top and bottom line growth. Adobe Creative Cloud, Document Cloud and Experience Cloud have become the foundation of Digital Experiences, starting with the first creative spark, to the creation and development of all content and media, to the personalized delivery across every channel. In Q4, we achieved revenue of $4.53 billion, representing 14% year-over-year growth. In our Digital Media business, we had our best quarter ever on net new ARR, delivering $576 million, and our Digital Experience business achieved its first $1 billion subscription revenue quarter, growing 16% year-over-year. The demand for digital content across every creative category, customer segment and media type is accelerating at a rapid pace. Creative Cloud remains the leading creativity platform, offering a comprehensive portfolio of products for every discipline across imaging, photography, design, video, web, animation and 3D. Core products such as Photoshop, Lightroom, Illustrator, Premiere Pro and Acrobat continue to lead their categories as we add new features and enhance their capabilities with Adobe Sensei, our AI engine. The rapid progress we’re making with Adobe Express is attracting millions of new users and delivering additional value to Creative Cloud members who are also interested in lightweight, task-oriented tools. New collaboration capabilities, like Share for Review, are integrated directly into Creative Cloud and Document Cloud applications to enable seamless creation, sharing and review across creative and document workflows. Our ongoing product innovation ensures that Adobe remains the preeminent destination for a wide and growing base of individuals, students, creative professionals, small business owners and enterprises to create and monetize amazing content more quickly and easily than ever before. Q4 was a record quarter for Creative Cloud. We achieved net new Creative Cloud ARR of $453 million and revenue of $2.68 billion, which grew 13% year-over-year. This strong performance was a result of: demand for our flagship applications, including Photoshop, Lightroom, Illustrator, Premiere Pro and Acrobat; expansion in SMB and enterprise, driven by strong execution of our year-end pipeline across direct sales and our reseller channel; accelerating growth in Substance 3D and Frame.io, underscoring the continued strength and significant opportunities in our newer businesses; momentum in Express, our template-based web and mobile product for creating everything from year-end sales promotions to holiday cards to social media posts. Express’ unparalleled collection of stock images, videos, fonts, design assets and templates and its unique integration of AI magic from Photoshop, Premiere Pro and Acrobat enable us to deliver the best of Adobe to customers of every skill level. Q4 continued to see exciting growth with millions of monthly active users, greater than 40% quarter-over-quarter visitor growth in the U.S., and an NPS greater than 50. Key customer wins include Electronic Arts, Meta, NBC Universal, Publicis, Roku, Target and United Nations. In October, we were thrilled to be back live with thousands of members from our creative community at Adobe MAX. The conference has always been an opportunity to showcase our incredible innovation, and we drove over a quarter of a billion video views across all channels. Our announcements included: powerful new AI capabilities in Photoshop, such as a one-click Delete and Fill tool to remove and replace objects, and a new Photo Restoration neural filter that instantly fixes damaged photos; a Share for Review service in Photoshop and Illustrator that enables designers to easily collaborate with key stakeholders; the first-to-market Camera to Cloud integration between Frame.io and RED Digital Camera and Fujifilm, significantly reducing production costs and time; advances in Substance 3D that empower brands such as Electronic Arts, Hugo Boss, NASCAR, NVIDIA and The Coca-Cola Company to create engaging immersive experiences; a new partnership between the Content Authenticity Initiative and Leica and Nikon to implement provenance technology into cameras, allowing photographers to embed when, where and how images were captured; and early demonstrations of Adobe’s Generative AI technology integrated into our tools, which promises to transform the creative process, making it more accessible, fast and efficient than ever before. Now turning to the Document Cloud business, digital documents have become synonymous with productivity in our personal and professional lives, whether it’s an offer to purchase a new home, a bank deposit form, a school permission slip or a sales contract. Document Cloud is the leader in digital documents, offering innovative solutions across every device and for every skill level. Our strategy to enable all common document actions, including editing, sharing, reviewing, scanning and signing across desktop, mobile and web, is paying strong dividends. In Q4, Document Cloud had record revenue of $619 million, which represents 19% year-over-year growth and strong net new ARR of $123 million, with ending ARR growing 23% year-over-year. Q4 highlights include: new Acrobat functionality for SMBs, including the ability to send branded agreement templates and combine payments with e-signed documents; new capabilities between Document Cloud and Creative Cloud to help knowledge workers and creative professionals seamlessly collaborate and improve their productivity; scan innovation that allows users to simultaneously scan the left and right pages of a book as well as scan both sides of an ID card on one page; strong organic growth in both traffic and searches for PDF capabilities, which serve as a critical funnel to Acrobat web; significant growth in Sign transactions within Acrobat, underscoring the need for integrated document solutions; outstanding growth in API transactions. API calls nearly doubled quarter-over-quarter, demonstrating the strategic necessity of integrating PDF capabilities within enterprise applications; key customer wins include BioNTech, Cigna, Deloitte, Mitsubishi Electric, Raytheon, Shell Information Technology and the U.S. Department of State. Q4 was the strongest net new ARR quarter ever for Digital Media, driven by outstanding execution against multiple growth drivers in our core business. In addition, we’re excited about the pending Figma acquisition, which represents a tremendous opportunity to accelerate the future of creativity and productivity for millions of people. Overall, the regulatory process is proceeding as expected. The transaction is being reviewed globally, including by the Department of Justice and the Competition and Markets Authority in the UK. We are currently engaged in the DOJ’s second request process. We expect that the transaction will also be reviewed in the EU. We continue to feel positive about the facts underlying the transaction and expect to receive approval to close the transaction in 2023. Every business in every category now depends on digital to engage and transact with their customers. Adobe’s Holiday Shopping Report, which analyzes trillions of data points in Adobe Analytics, found that Cyber Monday drove an all-time high of $11.3 billion in online spending, with mobile shopping now accounting for 55% of sales on Thanksgiving, and Buy Now Pay Later orders jumping 85% during Cyber Week. We predict spend will exceed $210 billion this holiday season. No company is better positioned than Adobe to capitalize on this large global opportunity. In my customer conversations, it’s clear that the current macroeconomic climate requires businesses to prioritize investments, and digital remains mission-critical to drive operational efficiency, improve customer engagement and maximize long-term value realization. We are driving a mix of diversified revenue streams through subscription and consulting services across new and existing customers, demonstrating the strength of our business. Experience Cloud is powering digital businesses in every industry across B2B and B2C with our leading solutions spanning data insights and audiences, content and commerce, customer journeys and marketing workflow, and it is unique in that it helps businesses drive customer demand, engagement and growth while simultaneously delivering productivity gains. Our comprehensive set of applications, including Real-Time CDP, are built natively on our highly differentiated Adobe Experience Platform, providing companies with a unified profile of each of their customers to deliver the most personalized, real-time experiences at scale. Adobe Experience Platform processes 29 trillion segment evaluations per day and executes a response time of less than 250 milliseconds, illustrating the impact of its real-time capabilities at scale. In Q4, we continued to drive strong growth in our Experience Cloud business, achieving $1.15 billion in revenue. Subscription revenue was $1.01 billion, our first billion-dollar quarter and representing 16% year-over-year growth. Adobe is differentiated in our ability to power the entire customer experience, from ideation to content creation to personalized delivery to monetization. Chipotle is a great example. They are using Creative Cloud to design content for web and mobile channels and Experience Cloud to highlight new product offerings based on consumer preferences and support a faster, easier and more customized online ordering process. In government, the State of Illinois is using Experience Cloud and Document Cloud to provide simpler and more equitable access to state services for over 12 million residents. It's especially inspiring to witness the positive social impact of Adobe technology. The National Center for Missing and Exploited Children has long used Photoshop to create age-progressed photos and uses Experience Cloud to facilitate the recovery of missing children. Additional Q4 highlights include: strong demand for Adobe Experience Platform and native applications, inclusive of Real-Time CDP, Adobe Journey Optimizer and Customer Journey Analytics, which are rapidly becoming the digital underpinning of large brands globally; accelerating demand for Adobe Experience Manager, demonstrating Adobe’s role in helping businesses effectively manage their content supply chain, from creation to monetization; a new Marketing Mix Modeling service as part of our data insights and audiences offering, which enables marketers to harness the power of Adobe Sensei to assess marketing ROI in weeks rather than months and forecast resources for campaigns more effectively; strong growth in partner and Adobe professional services, underscoring our customers’ continued focus on implementation and value realization; key customer wins, including BlackRock, Chipotle, Delta Air Lines, DFS Group, Disney Parks, Elevance Health, GM, Office Depot, Publicis, Santander and Wells Fargo. Adobe continued to receive strong industry analyst recognition, including leadership in the Gartner Magic Quadrant for B2B Marketing Automation Platforms, the Forrester Wave for Collaborative Work Management and the Forrester Wave for Enterprise Marketing Suites. As you know, in 2022 we experienced significant headwinds from the strengthening of the U.S. dollar, increased tax rates and the impacts from the Russia-Ukraine war. Despite those headwinds, in fiscal ‘22 Adobe achieved record revenue of $17.61 billion, which represents 12% year-over-year growth, or 15% growth in constant currency on an adjusted basis. GAAP EPS for the year was $10.10, and non-GAAP EPS was $13.71. We exceeded our initial Non-GAAP EPS target for fiscal year ‘22, which speaks to the discipline, strong execution and resilient operating model of the Company. Fiscal year 22 business and financial highlights included: Digital Media revenue of $12.84 billion; net new Digital Media ARR of $1.91 billion; Digital Experience revenue of $4.42 billion; cash flows from operations of $7.84 billion; RPO of $15.19 billion exiting the year; and repurchasing approximately 15.7 million shares of our stock during the year at a cost of $6.30 billion. In the fourth quarter of fiscal year ‘22, Adobe achieved revenue of $4.53 billion, which represents 10% year-over-year growth, or 14% in constant currency. Q4 business and financial highlights included: Digital Media revenue of $3.30 billion; record net new Digital Media ARR of $576 million; Digital Experience revenue of $1.15 billion; record cash flows from operations of $2.33 billion; adding over $1 billion to RPO sequentially in the quarter; and repurchasing approximately 5 million shares of our stock. In our Digital Media segment, we achieved Q4 revenue of $3.30 billion, which represents 10% year-over-year growth, or 14% in constant currency. We exited the quarter with $13.97 billion of Digital Media ARR. We achieved Creative revenue of $2.68 billion, which represents 8% year-over-year growth, or 13% in constant currency, and we added $453 million of net new Creative ARR in the quarter. Driving this performance was good linearity throughout the quarter as well as strong customer purchasing during the peak holiday shopping weeks. Fourth quarter Creative growth drivers included: new user growth, fueled by customer demand, targeted campaigns and promotions, and yearend seasonal strength, which drove strong web traffic and conversion rates in the quarter; adoption of our Creative Cloud All Apps offerings across customer segments, from enterprise, to Team, to individual and education; strength of the new Acrobat within our Creative Cloud offering, demonstrating the importance of digital documents and workflows to the creative community; sales of individual applications, including a strong quarter for our imaging and photography offerings; continued growth of newer businesses, including Express, Substance, Frame and Stock; and a solid finish to the year in SMB and enterprise. Adobe achieved Document Cloud revenue of $619 million, which represents 16% year-over-year growth, or 19% in constant currency. We added $123 million of net new Document Cloud ARR in the quarter. Fourth quarter Document Cloud growth drivers included: Acrobat subscription demand across all customer segments; continued growth of Acrobat web, fueled by online searches for PDF and product-led growth; strong performance of our new Acrobat offering integrated with Sign, driving upsell ARR as well as new customer adoption; and year-end seasonal strength in SMB, including through our reseller channel. Turning to our Digital Experience segment, in Q4 we achieved revenue of $1.15 billion and subscription revenue of $1.01 billion, both of which represent 14% year-over-year growth, or 16% in constant currency. Fourth quarter Digital Experience growth drivers included: expected year-end strength, with significant bookings of our newer offerings in EMEA that builds on our momentum in North America; success closing numerous transformational deals that span our portfolio of solutions; momentum with our Adobe Experience Platform and native applications, including RealTime CDP; strength with our Content and Workfront solutions, which are integral components of our content supply chain strategy; and increased customer demand for professional services, as enterprises focus on implementation and accelerating time to value realization from digital investments. In Q4, we focused on making disciplined investments to drive growth and awareness of our products. We continue to have world-class gross and operating margins and drove strong EPS performance in the quarter. Adobe’s effective tax rate in Q4 was 22.5% on a GAAP basis and 17.5% on a non-GAAP basis. The GAAP tax rate came in lower than expected primarily due to lower-than-projected tax on our foreign earnings. RPO exiting the quarter was $15.19 billion, growing 9% year-over-year, or 12% when factoring in a 3 percentage-point FX headwind. Our ending cash and short-term investment position exiting Q4 was $6.10 billion, and cash flows from operations in the quarter were a record $2.33 billion, up 14% year-over-year. We now intend to use cash on hand to repay the current portion of our debt on or before the due date, which we expect will reduce our interest expense in fiscal year ‘23. In Q4 we entered into a $1.75 billion share repurchase agreement, and we currently have $6.55 billion remaining of our $15 billion authorization granted in December 2020 which goes through 2024. As a reminder, we measure ARR on a constant currency basis during a fiscal year and revalue ARR at year-end for current currency rates. FX rate changes between December of 2021 and this year have resulted in a $712 million decrease to the Digital Media ARR balance entering fiscal year ‘23, which is now $13.26 billion after the revaluation. This is reflected in our updated investor data sheet, and ARR results will be measured against this amount during fiscal year ‘23. We provided preliminary fiscal year ‘23 targets at our Financial Analyst Meeting in October that take into account the macroeconomic environment and the growth drivers for our various businesses. While there is ongoing macro uncertainty, given the massive long-term opportunity in digital and the momentum in our business, we are pleased to reiterate those financial targets. In summary, for fiscal year ‘23 we are targeting: total Adobe revenue of $19.1 to $19.3 billion; Digital Media net new ARR of approximately $1.65 billion; Digital Media segment revenue of $13.9 to $14.0 billion; Digital Experience segment revenue of $4.925 billion to $5.025 billion; Digital Experience subscription revenue of $4.375 billion to $4.425 billion; tax rate of approximately 22% on a GAAP basis and 18.5% on a non-GAAP basis; GAAP earnings per share of $10.75 to $11.05; and non-GAAP earnings per share of $15.15 to $15.45. As a reminder, these targets do not contemplate our planned acquisition of Figma. We expect normal seasonality throughout the year, with Q1 being sequentially down and seasonally light for new business, sequential growth from Q1 to Q2, a dip in Q3 on account of summer seasonality, and a strong finish to the year in Q4. For Q1 fiscal year ‘23 we are targeting: total Adobe revenue of $4.60 billion to $4.64 billion; Digital Media net new ARR of approximately $375 million; Digital Media segment revenue of $3.35 billion to $3.375 billion; Digital Experience segment revenue of $1.16 billion to $1.18 billion; Digital Experience subscription revenue of $1.025 billion to $1.045 billion; tax rate of approximately 22% on a GAAP basis and 18.5% on a non-GAAP basis; GAAP earnings per share of $2.60 to $2.65; and non-GAAP earnings per share of $3.65 to $3.70. In summary, Adobe finished FY22 strong, executing on our strategies across Creative Cloud, Document Cloud and Experience Cloud. I expect this performance to carry into next year, as Adobe’s sustained top-line growth and world-class profitability continue to position us well for fiscal year ‘23 and beyond. Thanks, Dan. As the company celebrates its 40th anniversary, it is a perfect time to reflect on our past and our future. Adobe was founded on simple but enduring principles that remain with us today. Innovation is at our core, employees are our greatest asset and our customers, communities and shareholders are central to our success. Over the past four decades, Adobe’s continuous innovation and leadership have empowered billions of people around the globe to imagine, create and deliver the best Digital Experiences. Our strong brand and company culture enable us to attract and retain the world’s best employees. We are proud to once again be named to Interbrand’s Best Global Brands list as a top riser for the 7th year in a row and to Wall Street Journal’s Best Managed Companies, ranking number one for Employee Engagement and Development. We have everything it takes to continue our success in the future: massive market opportunities; a proven ability to create and expand categories that transform markets; an expansive product portfolio that serves a growing universe of customers; revolutionary technology platforms that advance our industry leadership and competitive advantage; an expanding ecosystem that delivers even greater value to customers; strong business fundamentals; and the most dedicated and talented employees. I have never been more certain that Adobe’s best days are ahead. Thank you. [Operator Instructions] We'll go ahead and take our first question from Mark Moerdler with Bernstein Research. Please go ahead. Thank you very much, and congratulations on the quarter and the guidance, by the way. Can you give us, David, some more color on Adobe Express and your ability to convert free users to paid users? Are you seeing any impact to creative customers trying to switch to Express? And how do you assure express paid adoption with that impact on Creative Cloud? Yes. We're very excited about sort of the state of Express. Express just finished its first year in market. We have millions of monthly active users. As I mentioned, we saw very strong growth sequentially quarter-over-quarter in the U.S., which is our primary focus market, 40% quarter-over-quarter growth in visitors, terrific NPS of over 50%. And that's really on the backs of hundreds of millions of stock content that we have, the 20,000 fonts that we've added that is unique to our offering, the highest quality templates. And the constant addition of best-breed features from our other Adobe products like Photoshop and Premier and Acrobat. We've had over 100 releases in the first year that Express has been out. So, we're very excited about that. And so, the Express business itself continues to do well, both in terms of free users and in terms of conversion of those users. But to your question, we also are seeing very strong adoption of Express within our existing CC customer base. So, we see a lot of people, of course, buying our core flagship applications for the power and precision that they have and that they represent, but there are times in those users that are looking to just get something done quickly. And the fact that Express is also entitled to those users gives them the ability to have the power and precision and the speed and ease. And so as users are coming, we're bringing in more users than we've ever had in audiences, we haven't reached by finding intent-based search for things. We're bringing those users in, which is giving us incredible top of funnel. We're driving the conversion. And we're also able to drive utilization increases in CC customers, which is driving retention of that business overall as well. So, the funnel and that migration of that base is very healthy and playing out as expected. I wanted to ask another question about Creative Cloud Express. Obviously, you're seeing some success here with that top of funnel business. Is there any color you can provide on where you see the upgrade path for some of those customers? Are there -- is there a certain upsell motion that we could see conversion of other products, even potentially the full suite in that installed base as it's growing? Thank you. Yes. As we talked about when we launched Creative Cloud Express, the primary focus right now is bringing people into Adobe Express and just making them successful, whether it's at the free tier or whether it's at the paid tier or whether it's a pay tier eventually migrating up into the core flagship applications. Our primary focus has been and continues to be right now around usage, repeat usage and utilization. We are seeing, though, while that's our primary focus, we are seeing a lot of really interesting data coming in suggesting that we -- that the upgrade has are -- while still early and not our primary focus are working. For example, in many higher ed institutions where we've started to deploy Adobe Express, we're starting to see not just the increase in terms of usage of Express, but we're also starting to see increase in demand for Adobe Creative Cloud flagship applications. And again, part of this is we know and we believe that everyone should be creative and creativity is the new productivity. But as people start to leverage and benefit from that creativity, they naturally want more power and precision as well. So that they do go well hand in hand. So, I'm curious, is there anything operationally that you can do in preparation for the Figma acquisition, either from an expense structure or development side now before close? And if so, what are those moves that you're making? Yes, Sterling, maybe I can speak to that. I mean, first, it's nice to see that since the deal was announced, the excitement associated with both what we can do as combined companies as well as, as you can see from our results, the interest in the core business. And so, we're excited overall associated with it. Certainly, as the regulatory bodies are looking at it, we can focus on thinking about strategically. We are getting a lot of great feedback from customers. But these are two separate independent companies. And as it relates to our own cost structure as well as our technology, we feel really good about all the prioritizations we've made. And so, we feel like we're uniquely positioned when it closes to immediately take advantage of it. My congrats as well on a strong finish to the year. Following up on Sterling's question, it's good to hear the Figma close process is moving forward as expected. Can you give us an update on how their business is trending, just relative to your commentary at the time the deal was announced, especially given the evolution of the macro environment since then? Thanks. Brad, as you know, they're a private company. And so, we're certainly not at liberty to talk about it. And they have to continue to execute on their opportunity by themselves. Thank you very much, and I'll add my congrats. So Shantanu, the amount of energy and excitement in the audience was quite impressive down at the MAX conference. And I'm wondering which of the innovations that you unveiled has created the most enthusiasm, which you might -- you think might also be monetizable? And I'm wondering whether it could be generative AI or that Share for Review capability, the intertwine capability or anything else really coming to the forefront. Well, Mark, firstly, thanks for being there, and it's clear that you were also looking at all of the cool new innovative stuff that was delivered. I always worry about questions like that because it's, you know, which of my children do I love the most. But let me just speak to, I think, thematically, what David and Scott showed, which is the core applications. We just continue to make sure the core applications are more accessible, more productive, more fun. And so I think that's one area, thematically, that the team has done an outstanding job of making sure that we continue to deliver innovative capabilities. You mentioned Intertwine and Illustrator. I think the second thing, thematically, we talk about how do we get more people into the franchise. David also referred to that when he answered the two questions on Express, which is, the more we get people into the franchise, whether it's through our trial products, whether it's through Express, whether it's through participating in the collaborative process. I think that only adds to the available market for Adobe. And so, I think the work that we're doing in collaboration is really continuing to democratize what we can do. So, I'm pretty excited about that. I think the AI and the sneaks that you talked about, that really -- the potential for that when you see whether it was the individual fonts that were being done or whether your ability through a text, to be able to get your content done exactly the way it is. I'm sure you've been tracking also what's happened, Mark, in terms of the chat GPT and what you can do with respect to text. So, I think that entire space, our vision has always been anybody who has a creative idea, how do you get that creative idea to life. And so, I think moving from the hundreds of millions to billions of people who can use it. You're right, that has profound impact in terms of getting more people on our platform. And I think you'll see us be quite aggressive about delivering more of that functionality in an augmented way, perhaps first starting with Express. But I think we're excited about all of that. And the Frame acquisition certainly also is off. I think David and Dan spoke to Substance. So, we feel really good about the multiple growth drivers. If I can adjust a little bit to that. The three examples you brought are really interesting examples because intertwine is an example of the ongoing innovation in our existing flagship application. So that continues to drive an keep people engaged and onboarding into the applications and keep those -- keeps everything fresh and differentiated. Share for Review that initial release, while still early, we've been amazed by the repeat use of that once people start using it. And that represents a great growth loop for us. Because, as you know, anyone that gets shared a document, whether it's a Photoshop document or an Illustrator document or any other document is also an opportunity as a stakeholder to turn into a future user of Adobe products, whether it happens to be the Photoshop document to Photoshop usage or whether it happens to be driving people to try Adobe Express. So, those growth loops are really interesting and important to us as well. And I just wanted to make sure people saw that opportunity. Shantanu, I'd like to ask about a term that you used often at MAX. And in fact, a new three-letter acronym that you use as well, namely product-led growth. And the question is Adobe has arguably been a product-led growth company for the more than 30 years that I've known you. And I'm wondering now what does product-led growth mean differently today from what it might have meant historically? And relatedly, how are you thinking about the cross-sell and upsell opportunity that you also spoke about at MAX, specifically for 2023. Yes. Jay, thanks for recognizing that our innovation has really come through an extremely close relationship with customers. So, I think in the past, in the desktop era, what product-led growth really was all about was making sure that as we engage with the customers, as we engage with the community, that we were able to use that. I think the best example perhaps in the desktop era was what we did with Lightroom. And when we first came up with Lightroom, given the fact that we had Photoshop already as a product, just getting the millions of people to use it even before we release the product, having all those evangelists and a great product, I think was a great example. What the team in both Creative Cloud and frankly, in the Experience Cloud, are doing is actually also following on the great work that we pioneered in the Document Cloud. And so, in the Document Cloud, I think product-led growth really related to as we think about what people were doing on searches when we introduced our web-based offerings for Acrobat, that's when we just started to see this velocity of how we engage with customers and prioritizing what's clearly top of mind for them, our ability to immediately satisfy them, I think, escalated quite a bit. When David came in, David really said, we've got to take this to a whole new level with product-led growth, and it's integrating both the community as well as, frankly, right now, engagement and engagement marketing in the product. And so when you get into product sessions right now, and you see the product manager and the engineering manager as well as the product marketing manager, all of them are on the same page. We have data. We have things instrumented in the products and your ability to do both AB testing and here's where we use our own products and the products that Anil does. And so, product-led growth right now is about saying, at any given time, we probably have three tests in market for a particular feature as well. And we're using that to really learn from the customer interactions and to deliver better quality products sooner. But David has really been the pioneer. So, David, if you'd like to add? And then maybe a little bit, Anil, on what we are doing for that in Digital Experience as well. Yes, Shantanu, I think that was a pretty complete summary. The only thing I would add is that there's an interesting inflection point that we are in terms of our product development cycles that give us an opportunity to take what we've always been doing, to your point, with product-led growth and drive even more use of it, which is the introduction of all the web applications that we have. So, we now have Photoshop Web, we have Illustrator Web, we have Acrobat Web, we have Adobe Express, and you combine that with the sharing focus that we have with Share for Review as an example. And we have new growth loops that we can start optimizing, and that's been a huge area of focus for the teams. Yes. I just wanted to add, Shantanu, as you said, several of our enterprise customers are starting to deploy their own product-led growth using our analytics technology, a banking customer, for example, one of our best customers. They have their online mortgage application, and they want to track who is able to use it successfully, who's able to complete applications completely online, and they're using our analytics technology to do that and see what works and what they need to do to fix it. So, we're starting to see like exactly, as you said, our technology being both used inside Adobe to drive our own PLG as well as customers doing it. And Jay, maybe to get to your second question and taking a step back, I do have to say, when we look at our annual targets that we had provided for Digital Media ARR at the beginning of the year of $1.9 billion. And I know even with our Q4 guide, I think people had some questions about where is the momentum. And I think the team crushed that, which I feel really good about. And so, a lot of that is happening as a result of just first, attracting and acquiring customers to the platform. And then what you're referring to is the cross-sell, upsell, whether it's people who first engage with us on a mobile device, whether it's people in Acrobat. We've used Adobe Reader as a very, very good on-ramp to allow people to engage with PDF functionality and then either get a license for our Acrobat web product or for the desktop product. Individual apps, the success and the driving of individual apps has always been an on ramp, and we then do a really good job because we use Adobe Experience platform to then convert them and even promotional pricing. I know we've had some questions in the past. And we have incredible data that shows us when people come in, whether that's on educational pricing and then they graduate or on promotional pricing, converting them to customers. So, I think there are numerous ways in which we've demonstrated that by personalizing our offer to every creative or knowledge worker that we're able to monetize that as well after they derive the value from it. Congrats on a strong net new ARR customer -- quarter. I wanted to ask about the composition of this number. The growth dynamic between Creative Cloud and Document Cloud was a little surprising. I mean Creative Cloud had, I think, the second strongest sequential percentage growth Q4 ever. But looking at Document Cloud, net new ARR didn't grow much sequentially in what's typically a stronger uptick in Q4. Can you just give a little more color on the seasonal dynamics you saw between Creative and Document Cloud in the quarter? Sure. Yes, I'm happy to do that. So first of all, yes, as Shantanu mentioned, we're very pleased with how FY22 has gone and how the quarter closed out, we saw a lot of strength in the core businesses. And our primary focus across these businesses continues to be around new customer acquisition, new customer ads. We also have a lot of diversity in terms of the drivers that we have and the leverage we have to drive the business. As we mentioned, we saw great strength across all of our creative segments imaging, photo, video, design. We also grew a lot of -- focused a lot in terms of new campaigns that are targeting new audiences for creative as well with a new campaign called Everyone can Photoshop, that's bringing customers in directly into the products and has been very productive in terms of driving top of funnel and conversion. On the -- in terms of new businesses for Creative, we're seeing a lot of strength from new businesses like Frame and Substance that have contributed more this quarter than ever before. And to your point, we've also been seeing a lot of strength in the core business around Acrobat. We're running a Acrobat’s Got It campaign really targeted at new customers in SMB where we show them all the capabilities that Acrobat has now, including specifically focused on signatures and things that really help them drive the business. So overall, the business is doing very well. The one dynamic that -- if you look at from an Acrobat perspective that we're really proud of too, is that we saw -- for the year, we saw growth of ARR at 23% despite the complicated macro. And it's important to remember that some portion of this is also -- the Acrobat business is also represented in the creative business. So, the Acrobat growth number is probably a bit understated in this point. Maybe one on the digital price side. We fielded some questions there just around guidance for next year in the current backdrop. You're holding on targets, grew well at 16% in constant currency for the quarter. So, can you just talk more around how much visibility you have in the targets there and it's how you closed the year at all, particularly given that EMEA comment provides incremental confidence in those targets going forward. Thank you. Thanks for the question. We are pleased with the performance of the Digital Experience business. I mean just as a quick reminder, at the beginning of the year, we had guided DX at 17% of digital growth for the year, which is what we achieved in a really tough year with all the different macro issues. So if I really take a step back, we're -- first of all, we're in a really strong position with our product portfolio. We are a clear leader in the market with the investments we made at the Adobe Experience platform starting 5 years ago. And that is really paying off with the book of business that we are seeing and all the customer adoption that we are seeing. And what we are hearing from our conversations with our customers is that they're really eager to invest in a platform that enables them to meet the mission-critical priorities around digital. And that's what we are enabling them and personalization in real time at scale. So, this is a significantly large opportunity. And what we believe is that as we go through this time, single product companies are going to come under a lot of scrutiny. So, while we definitely see deals getting scrutinized and going up to higher levels for approval, we also see that customers really want to invest in a market leader like us for their investments, it's going to last the next 10, 15 years to -- for the digital investment. So pleased with where we are. Maybe Anil, I'll just add a couple of things to what you said. I mean the first is that value realization has been top of mind for a lot of these customers. And so, I think if you look at the business as well, the services part, it's very clear that people want to implement it. And what I think is unique about Adobe's offerings in this particular space is that we help both with the customer engagement and frankly, the top of funnel as well as we help with productivity and cost. And so, it doesn't matter which side of that equation you are as, as an enterprise, I think both of them find that the Adobe Experience Cloud as well as, frankly, what we are doing with Sign actually help them on both fronts. And so we're pleased associated with that, and we have good visibility. I want to complement Anil and his team on the execution against the pipeline and transformational deals also, I think, just reflect the overarching interest that people have in making sure digital continues to be an imperative. And so, we're not going to be immune to the macroeconomic, but I like our differentiated solution and our execution. Thanks. Dan, in terms of your guide, are you implying the environment gets worse or stays the same. And for Shantanu, can you just talk about the next 6 to 9 months as we potentially go into a tougher economic headwind, how you're reshaping and rethinking your go-to-market or any steps that you can take to ensure you can cut through what is coming in. Yes. So, from a guide standpoint, we spent a lot of time talking about the environment we're in during FA day. Against that backdrop, you can see the momentum of the business. You can see the execution against the opportunities. What I really like about the way we're positioned in the market. There's a diversification of the company. It's end markets, it's product segments, it's business models, it gives us a resilience in the environment that we're in, and we see that in the momentum we're carrying into next year. There's really no change to the view of the environment that we're in, and you see that reflected in the targets that we set for 2023. So, we feel good about the way we're executing against a complicated macro environment, and we'll continue to stay focused on adding value to our customers, but there's a diversification and a resilience to who we are and a mission criticality of what we sell to our customers. And then you could see that in the comment that Shantanu made. You can see us impacting the company's top line. You can see us impacting the productivity with which they serve their customers, and that puts us in a pretty unique position. And Brent, as it relates to your second question, I'll unpack that in maybe two ways. First is we're really pleased with what we did and even when the pandemic first started about prioritizing what was really critical for us. And I think the prioritization exercise when you're really focused on your top imperatives, that's really helped bring clarity and alignment within the company that I don't think should be undersold in terms of how effective that has been for execution. As it relates to the next 6 or 9 months and you think about the three routes to market, digital continues to be an area of strength. I mean, I know through our Adobe Digital Index we talk about what we are seeing in terms of people continuing to engage with the customers -- companies that they want to transact with electronically. And so, on the digital side, we will just continue to make sure we focus on acquiring the customers. David spoke to some of the effective campaigns. Clearly, we understand the attribution of that. And we just have to remain vigilant on making sure that we're attracting the customers on the new platforms where they exist. And for retention, which is a key issue as well, just how they continue to get value from the offerings that they have. The partner ecosystem, whether that's for the small and medium business or whether that's for what we are doing with the SI and VAR community on Digital Experience, just continuing to enable them, continuing to engage with them. I think that's a part. Clearly, the small and medium business did see a rebound after what they went through last year, which was a really bad situation. So I think we have to remain vigilant on that. And I think on the direct sales part, as we look at our pipeline, December, despite the fact that it's our first month of our quarter, we will continue to focus on execution against that to take advantage of whatever budget flush exists in companies. And then, as you start to come to what happens in Japan in February as it's the end of their fiscal year, continuing to focus on Europe. Brent, Europe was actually one of the highlights for us in the quarter. I think Adobe Experience platform has done well. And so, we remain cautious clearly about the macroeconomic, but I think we have visibility into making sure that we can continue to execute, Brent. Hi. Thank you very much. And apologize in advance for some background noise. Shantanu and David, I wanted to direct this to you, if I could. The ARR net new in the quarter was very good, particularly relative to expectations. If we look back over a little longer period of time though than the quarter, growth has slowed in net new ARR, even if it's assuming of flattening out. And what I didn't -- what we didn't really get -- I think as much as we would have liked at the Analyst Day was, what do you think the key drivers of the net new ARR and creative have been or total ARR, if you want? And what are the key things that you're focused on before Figma that would cause an improvement in AR growth? I assume that one has been perhaps Adobe Express as a more compelling entry point. Is there anything else that you can call out as some things that you believe that Adobe is focused on like really some issues in the past that you think are going to be resolved and therefore before Figma but improve despite the macro or help growth in the creative side? Many thanks. Yes. I'm happy to jump in and Shantanu can add anything. So at a high level, if you look at what we've talked about at Analyst Day, our strategy is very clear, which is new users and retention are the core drivers and focus areas. As Shantanu mentioned, we're being very focused and very intentional in terms of those two things. When it comes to new subscribers, we added more new commercial subscribers this year than we've ever added in our history. And that is a really important intentional sort of activities we are doing. Many of those new users are -- tend to be nonprofessionals, right, or they tend to be earlier in career professionals. And so, they are coming in and leveraging our initial single app plan or Adobe Express, as an example, and we're very happy to have them take that on because we believe very strongly that the opportunities to drive and upsell them from Express to single app and from single app to all apps, is going to be something that is persistent and something that is very ready and available to us at the time we need. The main thing, though, is about getting them into the products and making them successful. And so with that focus, we've been very -- we've also been maniacally operational about retention of those bases. I think people have asked questions, as you broaden the net, you bring in other users that are not typical Adobe users, what's happening to the retention rates. I think we also shared that we're seeing usage of products continues to stay very strong as we bring in these new audiences. And we're starting -- and we're seeing retention continue to tick up and improve. And in fact, retention now is better than it was pre-pandemic as an example. So, we continue to bring in new users. We continue to retain those new users and we see organic opportunities to move them up and upgrade them. Shantanu mentioned a great example of education. We continue to see a lot of people come in with our education pricing. And then, we have the opportunity, two years or three years later when they graduate to upgrade them to full commercial pricing. And those activities are playing out as expected, and we see a lot more opportunity to it. But it all comes down to bringing new users in, getting them using the products a lot and retaining them. And maybe to add to that, Keith. I mean, when you think about the newer businesses that we're talking about, video just continues to be a really key growth driver, 3D and immersive imaging and photography. But if you take a step back, I think that two things happening in the macroeconomic environment that are actually going to be tailwinds. The first is the fact that it is the golden age of design. Everybody would like to express themselves. There are more screens on which all of this content is being consumed. So, I think the insatiable consumer demand for content, I think, is certainly driving a lot of more content that's being created. One of the exciting areas that I think David and Anil have talked about is what we are calling content supply chain. And when you take even the larger companies, they are all trying to get a handle of as they engage digitally with customers how much content is being created? Where is it being created? Where is it being delivered? How do I localize it? What's the efficacy of that content? And so, I think this content supply chain and everything we have with our creative applications, our asset management, the fact that we then deliver that content, I think we continue to believe that that's going to be a growth driver for the entire business as well. So, I wouldn't underestimate the insatiable consumer demand but I also wouldn't underestimate what's happening as enterprises recognize that the way to engage with people is to personalize that content. Hey operator, we're at the top of the hour. We'll make time for one more question, and then we'll wrap up. Thanks. I apologize for any background noise. I guess we've heard a lot about the continuing growth initiatives in the demand environment, sounding like it's pretty resistant to any macro pressures I believe you're seeing at the moment. I'll ask the kind of other side of the equation. As you think about the levers that you have on the margin side, the discipline that you've been exhibiting. It does seem like over the last quarter and maybe the past few quarters, that margin story, that margin discipline has continued to exceed at least our expectations. So, as we look at the next year, as you think about the levers that you have in the business if the parts of the business should slow. Can you go through maybe walk through a little bit of where you see the opportunity to either, A, lean in or B, pull back? And also, how we should think about cash conversion in that scenario from a cash flow perspective. Thanks again. Yes. So from an operating performance standpoint, you rightfully point out, the Company is performing really, really well. But we're doing what we've always done inside the company, which is drive growth, deliver industry-leading products and innovation to our customers, help them become more effective on the critical path of driving revenue for their business. But we do it in a very disciplined way that drives margin and cash flow while driving growth. And we talked a lot about Rule of 40 at our FA day. If I were to take a step back and reflect on FY22, it's complicated macro environment, and we’re operating at a rule of 60 for the year. So, we feel really good about our ability to operate. And so as I look forward into next year, we're going to continue to lead. We're going to continue to innovate. We're going to continue to make our customers successful, but we'll continue to do what we've always done, which is ruthlessly prioritized where we make our investments, constantly review the portfolio, prioritize the things that are going to drive long-term value for our customers and do it in a very disciplined way. So, that's the operating tone inside the company. Nothing's changed on that front. We feel really good about how we're executing in the environment and the momentum we're carrying into 2023. From a cash flow standpoint, it all starts with driving that discipline in the business and we'll continue to drive cash flow and deploy that excess cash on a quarterly basis to create value with the shareholders. And Alex, given that was the last question, let me start off by saying as we celebrate our 40th anniversary, it's both humbling and inspiring to think about the impact that Adobe has had on the communication world and what we've been able to do. And it's rare to be able to say at this level that we believe that our best years are ahead of us. If I take a step back and I look at what we had done in 2022, there are three things that stand out for me, the Digital Media ARR and just continuing to drive new customer acquisition and deliver innovative products across both, the Creative Cloud and Document Cloud. We've done a really good job of demonstrating why creativity and design is going to be more important and also combining creativity with productivity. On the DX side, the organic creation of the Adobe Experience platform and its apps, and the success that we've seen associated with that, the fact that we just had a first $1 billion quarter as it related to subscription revenues, I think that just reflects both the fact that we created this category. And unlike all of the other enterprise software companies who are in that space, we're just ruthlessly focused on this. And it is unique in that it helps both the top line and bottom line for enterprises. And to the question that you specifically asked, Alex, I mean, profitability, despite the FX impact that impacted hundreds of millions of dollars when you look back and say, at the end of the year, we exceeded our non-GAAP EPS that we had said a year ago/ I think that is a really amazing performance by the finance and operations team of making sure that we continue to remain focused. And I think as it relates to go-forward, we've clearly talked about why we're excited about the innovative road map, why we're excited about all of the things that are going to come up in 2023 and beyond. And so, I think it was a good year. We will continue to remain focused. I want to thank our employees who really are the unsung heroes of all of this execution and the work that they do. And for every one of you, thank you again for your interest in Adobe and happy holidays and wishing you all a joyous holiday season.
EarningCall_1408
Greetings, and welcome to the Simulations Plus First Quarter Fiscal 2023 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, Brian Siegel, from Hayden IR. Thank you. Mr. Siegel, you may begin. Good afternoon, everyone. Welcome to our first quarter fiscal 2023 financial results conference call. With me today is our CEO, Shawn O'Connor; and CFO, Will Frederick. After their portion of the call, we will open the floor to questions. Before we begin, I want to remind everyone that except for historical information, the matters discussed in this presentation are forward-looking statements that involve a number of risks and uncertainties. Words like believe, expect and anticipate mean that these are our best estimates as of this writing, but that there can be no assurances that expected or anticipated results or events will actually take place. So our actual future results could differ significantly from those statements. Factors that could cause or contribute to such differences include, but are not limited to, our ability to maintain our competitive advantages, acceptance of new software and improved versions of our existing software by our customers, the general economics of the pharmaceutical industry, our ability to finance growth, our ability to continue to attract and retain highly qualified technical staff, our ability to identify and close acquisitions on terms favorable to the Company, market conditions, our ability to identify and enter into a definitive agreement with a broker to administer the share repurchase program authorized by our Board in a sustainable market. Further information on our risk factors is contained in our quarterly and annual reports and filed with the U.S. Securities and Exchange Commission. Thank you, Brian. Happy New Year, everyone, and thank you for joining us on our first quarter conference call. This afternoon, we reported first quarter results in line with our fiscal '23 guidance for both revenue and profitability. First quarter revenue was approximately $12 million, down about 4% year-over-year and in line with the expected changes in seasonality we discussed on our last earnings call. As a reminder, the reason for the change in seasonality relates to deliberate changes we made to simplify our software renewal process by aligning customer renewals across groups and products within each customer. Years of acquisitions, new product introductions and penetration into multiple groups within multiple products within individual customers drove these changes. For the first quarter, EPS was $0.06, and our adjusted EBITDA margin was 25%. As anticipated in our guidance, investment in employee growth, retention and recruiting impacted our operating leverage and will continue to do so throughout fiscal '23. This impact is reflected in our first quarter results just proportionately as it is now our seasonally lowest revenue quarter. Finally, we are also currently seeing a change in behavior at some new and existing customers with new sales and upsells aligning to early calendar 2023 budgets. These near-term changes as a whole do not change our outlook for our business in fiscal '23 and beyond. Modeling and simulation tools have become a key component of the drug development workflow and we expect continued growth. The first quarter was highlighted by significant achievements in support of our clients in both our software and service businesses. We were recently awarded two new FDA grants developing and validating novel model approaches for local gastrointestinal and pulmonary delivery routes. These newly funded awards achieve a significant objective for us as we will now be partnering with the FDA to provide validated, innovative solutions for all major dosing routes around the body. There are a few, if any, organizations that have six funded partnerships with the leading global health authority entering 2023 like Simulations Plus. A large pharmaceutical company utilized GastroPlus to perform virtual bioequivalence trial simulations, assess potential pH-dependent drug-drug interactions and justify product specifications for their new tablet formulation of CALQUENCE with the aim to offer physicians and patients increased flexibility when devising treatment plans. The results were used to inform regulatory decisions and accelerate approval. A large pharmaceutical company, in partnership with the experts at Simulations Plus, developed GastroPlus models to evaluate the impact of meal contents and intake timing on drug exposure for new dosing regimens of Trulia with the aim to increase patient compliance and tolerance. The results were used to inform regulatory decisions and accelerate approval. We are wrapping up a project with a top 20 pharma client on a major clinical trial optimization effort. In a scenario with significant recruitment and endpoint selection challenges, the client uses our QSP disease modeling tools to pick the correct patient population and the endpoint for efficacy. Regulators are being approached now with the results. We are targeting more projects like these where we provide end-to-end program directives. And in fact, we already have another similar program in the works. In another project with a top 20 pharma client, we completed the general analysis of the target mechanism of action in NASH with our NAFLDsym software, allowing them to reprioritize in-house assets in their pipeline. This will bring cost savings and efficiencies for the client and has led to more work to come with the client. For a midsized pharma client, DILIsym identified the mechanism for a clinically known liver safety issue and help them pick the correct dosing range to take forward safely. An investment firm that takes equity positions in publicly traded clinical-stage life science companies hired us for a rapid turnaround project. The goal was to predict a clinical trial outcome using only publicly available information for one of their holdings before it made a public announcement. After running simulations, our prediction suggested positive results from the trial. The investment firm then significantly increased its position in this company ahead of the public release of the trial results, which came approximately two weeks later. The results were positive as our science predicted and the stock price increased 4x to 5x post announcement. The investment company has already approached us for additional projects in other therapeutic areas where they'd like to invest. The experts at Simulations Plus supported a small biotech company in their pursuit of a therapy to treat inflammatory bowel disease. The first-in-human simulations projecting local concentrations within the gut were included in the Company's pre-IND briefing book and will be provided to regulatory agencies to support dose selection for the upcoming first-in-human studies. These highlights demonstrate the numerous means in which we assist our clients in optimizing their drug development strategies, utilizing model-informed drug development approaches and the ever expanding use cases for the application of modeling and simulation techniques across the drug development cycle. Moving to our software business. Revenues were down 17% in the quarter due to our change in renewal strategy. As we said last quarter, we took deliberate actions to align software renewal timing for our customers, which we expected to impact our first quarter revenue seasonality while boosting our second through fourth quarter results. Also, as expected, we're seeing some new sales push into our second quarter to align with customers' new calendar year budgets. The renewal patterns are progressing as expected, and we added 15 new customers across the portfolio during the quarter and saw continued strength in our cross-selling strategy with 15 upsells. While GastroPlus was hit hardest in the quarter by the renewal alignment with revenue down 24%, we still added one new customer, made eight upsells to existing customers and saw 14 peer-reviewed published journal articles. These are all encouraging data points given the shifts in customer budgetary timing for new sales and renewals. MonolixSuite revenue declined 1% in the quarter due to the renewal alignments and foreign exchange impact. However, we added two new customers and made two upsells to existing customers during the quarter. ADMET Predictor revenue declined 25% in the first quarter reflecting timing adjustments in our renewal strategy. Despite this, we added four new commercial customers and made five upsells to existing customers in the quarter. Our University+ program continued to grow and now represents 266 licenses in 54 countries. This program integrates our software into educational facilities and makes it part of advanced curriculum while seeding the market of next-generation modeling and simulation professionals to drive future demand. Positive growth momentum in our service business continued in the first quarter with 17% revenue growth and backlog growth to $15.8 million. Operationally, we added five consultants to our team, which we expect will help convert backlog to revenue in the coming quarters. Finally, we enjoyed a successful fall conference season and continued to expand our virtual workshop programs. PKPD revenue increased 23% this quarter. We experienced a shift to higher-margin time and materials contracts from fixed-price projects, which contributed to expanding our service and profit margins. QSP/QST revenue decreased 28% for the quarter due to the more volatile nature of these high-dollar value longer lifestyle projects. PBPK revenue increased 74% for the quarter, reflecting the deeper implementation of PBPK modeling, including an overall expansion of use cases and higher perceived value and impact. As you saw in our press release, we have an evolving capital allocation strategy that I would like to briefly outline. We have three areas of focus: corporate development, which drives inorganic growth; internal investment, which drives organic growth; and finally, returning capital to shareholders. Internal investment remains a top priority as it drives our expected 10% to 15% CAGR for organic growth over the next several years. Most important is our investment in R&D to expand our product functionality and new offerings that maintain our technological leadership in modeling and simulation and support organic growth. In addition to revenue growth, our goal is to increase efficiencies and drive operating leverage in our cost structure. While operating leverage is expected to decline in fiscal 2023, longer term, we expect scientific employee retention programs and strategic hires we made, combined with selective headcount growth in sales and marketing will continue to drive revenue growth and operating leverage as experienced historically. Internal technology is also part of the equation as we enhance our systems to drive further efficiencies across the Company. Next, we have evolved our inorganic growth strategy beyond M&A to a broader corporate development focus. In August 2020, we sold 2.1 million shares at $55 per share for net proceeds of $108 million for M&A purposes. Since this offering, we identified more than 60 potential candidates that initially met the Board's M&A criteria, which includes strategic and cultural fit, immediate EPS accretion, revenue synergies and attractive valuations. We engaged in various levels of discussion with all of these candidates, but we have not as yet closed any deals. This does not mean we've exhausted all options. We expect many of these discussions to continue, but we have nothing to disclose at this time. While acquisitions will remain a top priority for inorganic growth in light of the evolving market conditions, we will expand our corporate development strategy to allow for strategic investments and building strategic partnerships with companies that could lead to potential future financial upside. This change will enable Simulations Plus to cast a wider net of relevant companies previously screened out or allow us to gain access to leading-edge trends and technology in biosimulation or adjacent markets. Finally, with regard to returning capital to our shareholders, the Board approved a $50 million buyback program. Given our current cash position and free cash flow accumulated since the offering in 2022, we believe we can still execute corporate development initiatives while offsetting a portion of the dilution from the 2020 capital raise. We believe that this evolving strategy optimizes the combination of organic growth, operating leverage, inorganic growth and return on investment to our shareholders. Looking to the remainder of fiscal 2023, we remain confident in achieving the guidance we provided last quarter. As a reminder, our full year revenue target is 10% to 15% organic growth, which translates to $59.3 million to $62 million. As we said last quarter, we will continue investing in our people while selectively adding headcount in certain areas to support our long-term growth targets. This means fiscal 2023 will be a transition year for our cost structure leading to lower margins and restraining EPS and EBITDA growth. We believe these actions are prudent and will benefit our longer-term revenue growth while returning to a model with strong operating leverage. We expect to achieve diluted earnings per share of $0.63 to $0.67, which translates to 5% to 10% growth. Thank you, Shawn. Total revenue declined 4% in the quarter, comprised of a 17% decline in software and 17% services growth. Total revenue decline was approximately 1% on a constant currency basis. Software represented 51% of revenue during the quarter. Gross margin was flat year-over-year at 78%, reflecting the lower software mix, offset by higher services margins. Software gross margin decreased to 85% due to the lower revenue and foreign exchange rate headwinds. Services margin increased to 70% due to a higher bill rate this quarter. For the first quarter, GastroPlus represented 50% of software revenue, MonolixSuite was 26%, ADMET Predictor was 18% and other software was 6%. For the quarter, our customer renewal rate was 82% based on accounts and 90% based on fees. These lower rates reflect the renewal timing changes Shawn mentioned, the impact of FX rates for our EMEA and Asia Pac customers as well as some of our smaller biotech customers not renewing their licenses. Generally, the smaller customer non-renewals are offset with our price increases for larger customers as reflected in the higher fee-based renewal rates. The decline in average revenue per customer is reflective of the new smaller biotech companies that we're adding as new customers as well as the seasonality of our software business. We expect quarterly comparisons to prior periods to fluctuate throughout the fiscal year with our new seasonal expectations. Shifting to our services business. Our first quarter services revenue breakdown was 49% from PKPD services, 18% from QSP/QST services, 25% from PBPK services and 8% from other services. Other services consist primarily of regulatory services we provide our customers to help them meet global regulatory compliance and quality requirements. We also provide comprehensive learning services focused on modeling and simulation training with a variety of options to help our customers succeed. Regarding key services metrics, total services projects worked on during the quarter increased 14% this quarter compared to last year and backlog increased by approximately $1 million from last year to nearly $16 million. Now turning to our consolidated income statement for the quarter. Total R&D costs for the quarter were $2.1 million or 17% of revenue compared to $1.7 million or 14% of revenue last fiscal year. R&D expenses for the quarter were $1.2 million or 10% of revenue compared to $0.9 million or 7% of revenue last year. Capitalized R&D for the quarter was $0.9 million or 7% of revenue compared to $0.8 million, also 7% of revenue in the same period last year. SG&A expense for the quarter was $7.2 million or 61% of revenue compared to $5 million or 40% of revenue last year. Scientific headcount and compensation increases were the most significant driver of this increase. Income from operations was $0.9 million, while operating margin was 7%. Q1 revenue is now our lowest revenue quarter for the fiscal year, which impacts our profitability with relatively fixed payroll expenses. As quarterly revenue increases through the end of the fiscal year, the corresponding profitability will improve each quarter toward the level provided in our fiscal year guidance. Interest and other income was $0.7 million this quarter versus $0.1 million last year. This reflects stronger returns from higher interest rates on our investment portfolio balance. Income tax expense was $0.4 million compared to $0.8 million last year, reflecting an effective tax rate this year of 23% compared to 22% last year. The first quarter typically has the highest effective tax rate since the annual tax expense for our France division is included. We still expect our effective tax rate for fiscal 2023 to be closer to 20%. Q1 net income was $1.2 million and diluted earnings per share was $0.06. The revenue impact for the quarter from foreign currency exchange was $290,000 and expenses related to M&A during the quarter were $345,000 for a total of $635,000 or about $0.03 diluted earnings per share. Adjusted EBITDA for the quarter was $3 million, and adjusted EBITDA margin was 25% compared to adjusted EBITDA of $5.3 million or 42% margin last year. As a reminder, we calculate adjusted EBITDA by adding back stock-based compensation expenses and expenses related to M&A or other noncash non-operating expenses. We provide a reconciliation of this non-GAAP metric to net income, the relevant GAAP metric in our earnings release and on our website. We ended the quarter with cash and short-term investments of $132 million and no debt. We believe we are well capitalized with sufficient cash to support our capital allocation initiatives. Accordingly, the Board has authorized a share repurchase program to repurchase up to $50 million of outstanding common shares as part of our ongoing commitment to drive shareholder value. We intend to enter into an accelerated share repurchase transaction during the second quarter for the repurchase of $20 million of our outstanding common shares. We believe the remaining funds on hand plus our free cash flow will be sufficient to continue our pursuit of strategic acquisitions and investments. Now I'd like to provide some further commentary on our fiscal 2023 guidance with the expected changes in quarterly seasonality this fiscal year. First, we expect our second quarter revenue growth rate to be between 7% to 11% compared to last fiscal year. As we mentioned before, Q2 through Q4 revenue should be more evenly distributed for the remainder of the fiscal year compared to prior years. This should result in the largest quarterly growth rate occurring in Q4 compared to last fiscal year. Second, I'd like to reemphasize the generally fixed nature of our cost and expenses, primarily related to employee compensation and total rewards. Total costs and expenses are calculated by adding cost to revenue plus R&D expense plus SG&A expense. While the allocation of costs and expenses amongst these three categories is largely driven by the type of work our employees perform each quarter, the total amount is expected to increase as we add headcount or increase employee-related costs, offset by the amount of capitalized R&D performed each quarter. Third, even though our total costs may result in fluctuations each quarter as a percentage of revenue, we still expect to see the same annual trends we mentioned in our last earnings call for fiscal '23. Specifically, increasing software and services gross margins for the fiscal year compared to last year, R&D expense as a percentage of revenue for the fiscal year in the range of 6% to 8%, operating expense as a percentage of revenue for the fiscal year in the mid-50s and an effective tax rate for the fiscal year of approximately 20% plus any additional impact from the new excise tax on stock buybacks, depending on the actual timing of the repurchases. Fourth, we saw an increase in interest income this quarter compared to last year as interest rates have gone up substantially since then. We expect interest income for the remainder of the fiscal year will be impacted by four things. One, interest rate changes during the rest of the year; two, the $20 million accelerated share repurchase we expect to fund this quarter; three, the actual timing of share repurchases during the fiscal year for the remaining $30 million of the repurchase program; and four, the timing and amount of any strategic acquisitions or investments that we make during the fiscal year. Finally, we expect diluted earnings per share for the second quarter to be between $0.17 to $0.19. Accordingly, diluted earnings per share for the second half of the year is anticipated to be between $0.40 to $0.42 to achieve our fiscal year guidance target of $0.63 to $0.67. We hope this additional commentary helps communicate our expectations for quarterly year-over-year trend comparisons with the shift changes this fiscal year. As previously mentioned, we do not expect these quarterly shifts to have an impact on our fiscal year performance and annual trends. Thank you, Will. This quarter unfolded as we expected. The adjustments we are making to our business, including hiring scientists, and expanding our sales and marketing organization, while adjusting renewal timing to facilitate cross-selling are driving the intended results. While these changes impacted our consolidated results in the first quarter, we're confident we will achieve our full year outlook. I'm proud that we continue to deliver on our commitment to science, driving greater adoption of in silico tools to accelerate innovation and reduce costs. We are investing in internal R&D efforts to maintain and grow our leadership position and our increased scale enables us to expand our industry collaborations. We continue expanding our strong global regulatory relationships and now have multiple FDA technology development collaborations. Thank you for your time and attention. And I will now turn the call over to the operator for the question-and-answer session. Thank you. Ladies and gentlemen, at this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Matt Hewitt with Craig-Hallum. Please proceed with your question. Maybe a couple. First, on the renewal side, last quarter, when you talked about the shift in strategy as far as allowing your customers to kind of line up the renewals across suites and products and then there was also the piece that was tied to budgets and the shift to the January budgets for your customers. Is there any way to kind of break out or look at that second piece as far as the budgetary aspect of it? And maybe talk a little bit about what you're seeing so far here through this quarter -- through Q2, which includes January and what you're seeing? I realize it's very early days, but what are you hearing from customers from the budgetary standpoint? A fair question, Matt, I don't know that we can quantify the split between the two, but there's always been a phenomenon in the industry in terms of spend budget for this year as we get to November, December where we lose it and then waiting for new budgets, new dollars to be available after the first of the year and the new budget year. I think what we experienced or saw is a handful of deals that were potential deals that might have occurred before the end of the calendar year, that in these situations, we've not lost those opportunities. Those opportunities were earmarked for spending by our clients in the new calendar budgets after the first of the year. I'll check with the team. I'm not sure by January 4, we've cut some closed this yet, but we anticipate that they will now come through this year. And on the other side, we saw a lot more conservativeness on the part of our clients in terms of not spending out excess dollars in their budget ahead of time before the end of the year, like we've seen sometimes in the past. So a handful of deals in that side of the ledger that got pushed off or delayed into the second quarter. And then on the other side, on the renewal side, pretty good visibility out to the renewal activity of our clients and the changes that we're making to line them up, and that was pretty anticipated. Expectations for the quarter came in exactly where we thought they would. That's great. And then shifting gears a little bit, the $50 million share repurchase program that makes complete sense. But you're also implementing a little bit of a shift in your strategy as far as looking for more or the possibility for some strategic investments or partnerships. Help us, what are you thinking along those lines? I mean is this a $10 million investment into a software company? Or what could that look like? And more importantly, I guess, from a shareholder perspective, how would that investment flow back to your shareholders? Sure. Fair question. First, I'd highlight that the acquisition effort is still number one focused here. And while we've all been a little frustrated in terms of the speed to closure, there are a number of good candidates that are still in discussions, and we hope that those will continue and come to fruition at some point in the future. The strategic investment opportunity sort of expands with the same objective, same objective of finding good technology fits that open up TAM, open up market for us in an inorganic way going forward, same objective with the strategic investments. So we find a lot of technology players out there and the marketplace aren't really entities that are ready for acquisition amongst the criteria that we listed off, be it accretion or valuation expectations for some, not start-up, but early-stage companies. And our opportunity there is to partner with them. The company has a rich history of collaboration, those collaborations that we do time and time again with our large pharma clients, collaborations that we do with the FDA whereby we work with a partner. And that effort results in technological advancement that finds its way into our product suite. And with some of the opportunities out there that might not be today ripe for acquisition, there's opportunity to, in a lesser dollar point to make a strategic investment in a partnership that allows for some technology sharing and some development of our products or it could be go-to-market strategies, along with that entity that open up opportunities for us. The payback in the end is the same payback from an acquisition, an opening up of a market and enhancements of our existing products that delivers a larger TAM and larger opportunity for us in the long run. Got it. And maybe one last one, and then I'll hop back in the queue and maybe touches on that a little bit. So there's been a step-up in R&D investment here the past couple of quarters, a little bit more pronounced here in Q1. Is there anything tied to that? Obviously, you called out that you've got six different federal or FDA partnerships, if you are -- or contracts that you're working on, but typically, those dollars kind of offset R&D. So is this some internal investment? Is there something that you're investing there? Or is something else that's sitting in that line? Yes, Matt, I think yes, some incremental spend there as the scientific resources are allocated during the quarter into development work there. I think the percentage there probably exaggerated a little bit because of the lowest quarter top line revenue causing that percentage to go up a bit as well. We'll give guidance for the year. I don't know that the R&D for the year will come out any different than our historical payout in there in the long run. Maybe you could just talk a little bit more of where you're seeing some of the investment by therapeutic area or drug development area. You'd mentioned NASH, I was just curious on that area, given -- I remember a year ago, you had seen some pullback in spending on NASH-related projects. And anything you'd say on some of the oncology products as well, that would be great. Sure, Dave. Yes. No, we've not pulled back. There's an ebb and flow in terms of the client activity in the therapeutic areas, and NASH has been one that the NAFLDsym product and our QSP/QST group supports clients in that area on an ongoing basis, we just had a significant project this last quarter there. It ebbs and flows. Oncology area, one of the stronger areas in terms of drug development today, an area that we support as well. Neurological therapeutic endeavors is a larger area for us as well. But the service group performs across the board, the full spectrum of therapeutic areas. Just a couple here. You talked about TAM expansion. The example you gave with the investment company that used the software to gauge probably success of a clinical trial outcome. I was just wondering if you disclose how you would charge an investment company and is it related to maybe the profit that they can make off a correct decision? Or is this a project that you think that could significantly actually expand the TAM that you're currently looking at? Or is it kind of a one-off? Hopefully, it's not a one-off, Frank. It's an area that knocked on a lot of doors over the years with modeling and simulation support to either capital entities or investment companies and sporadic success in that regard. It was a highlight during the quarter. Very successful project performed. I would say that our model there has been similar to the work we do for our more traditional clients and that we do work for fee, whether it's timing materials or fixed rate. We don't do our service engagements with any future drug success royalty stream or in this case, they return on investment opportunity as part of the proceeds of our work effort there. But it's priced accordingly as best we can. And it doesn't really have an indirect impact in terms of the strategic investment opportunities that we're looking at in terms of expanding our TAM. If that market opens up and we can do more work like that, it will be incremental to our business but not a large TAM. Okay. Great. And then in terms of the strategic partnership angle, is this -- is it fair to assume that this was just not part of the plan in terms of corporate development in the past outright acquisitions and now this expands it? Or was it also somewhat part of the plan in the past? I would say that it really wasn't a focus on our part. We were very focused in terms of the -- continuing the success of prior acquisitions, which were always very focused on stand-alone entities with the criteria that we listed off with an acquisition orientation and not really an open eye to opportunities that might not be right for acquisition at this point in time, but a strategic investment would link the two organizations, could lead ultimately to an acquisition down the road but most importantly, would open up some technology sharing or market capability sharing the will enhance obviously both companies in the shorter run. Okay. Great. And in terms of the business model, is it fair to assume this would be some sort of a biotech kind of upfront and milestones in royalties with the partnership or too early to disclose. Each deal can take its own form based upon circumstances. Our focus is primarily in terms of, again, like our acquisition strategy, we'll be focused on software opportunities, service opportunities as well, but software opportunities that can build the technology either within our products or in some linkage to other capabilities in third party's hands. And those terms of those strategic investments can take many, many forms. But I wouldn't limit it to a sort of drug oriented -- drug development oriented milestone royalty type of arrangement. Okay. Great. And just lastly here. I'm sorry if I missed this. But in terms of the stickiness of the business, obviously, the change in seasonality, but the stickiness had already been there on the 95%. And I think you had mentioned some of the 5% that's not necessarily sticky. It is either maybe a company getting out of business or just due to M&A. Is that stickiness still there around the 95%? Absolutely. The renewal rate is anticipated as certain renewals that previously would have been in the first quarter because of the change in the renewal pattern here will happen during the course of the year. It's reflected by our guidance of 10% to 15% for the year. Underlying metric there is that 95% -- 93% to 95% renewal rate, and that will occur. But as we indicated last quarter, first quarter would be impacted by the push out of renewals into the second, third and fourth quarter, and hence, on a year-over-year basis, you see a little dip in the for free renewal metric. Just a couple. First, if you could just provide some more color on the headcount additions in terms of -- is it ahead of where you expect it to be as you head into the second quarter and the remainder of the year? And are you seeing any change in easing in terms of availability of candidates and even compensation? Mitra, as we've indicated, it's a very competitive market out there for scientists and computational biology, and therefore, we were extremely pleased with the success we had this past quarter in both regards in terms of the additions, the recruiting and new hires that we're able to bring on board as well as our retention profile for the quarter, very successful quarter on the people front for the Company. Are we done? No, we're continuing through the course of the year to look for new talent to bring on board. And successful first quarter gives me high expectations for our ability to continue to operate the plan. Okay. And just coming back on the M&A side. I know you mentioned since August 2020, you identified more than 60 candidates that sort of met your criteria, but you haven't announced any closure, so to speak. And I'm just curious, what has sort of been like maybe the biggest sticking point or maybe a few things that you think might have just led to not being able to get a deal done? Yes. It's a range of scenarios, not the smallest of which, probably top of the stack is companies are not always in a position where they're looking to be acquired. And so that is a scenario that's often encountered in those instances where there is interest, the accretive nature of their business, it being at the stage that would allow us to fulfill the criteria which that we're not interested in non-accretive acquisitions, that would be a stumbling block in cases. And then finally, attractive valuation, the dynamics of which have changed over the course of the last couple of years as health care multiples have risen and fallen and over time, those valuation discussions have changed and evolved. But in the end, valuation is always a key criteria to come to agreement on that. Okay. And then finally, obviously, you have a lot on your plate in terms of the domestic market. But I know you've always talked about exploring opportunities in Europe and even in Asia. Just wondering, if you're having any traction on that front? Good traction. We service Europe directly. We service Asia and Latin American markets through distributors. And we're seeing a pickup in terms of the distributor geographies. They were, in some cases, more impacted by COVID, more impacted for a longer window of time, and those seem to be improving, probably the exception to which is obviously the Chinese market. But there's some promise of that opening back up here of late and the Latin America market, which we initiated a new distributor agreement late in the last fiscal year. It looks to be contributing very well to us as we move into the new fiscal year here. European marketplace is pretty robust. We bank on the service side to see more boots on the ground for scientists local in that territory and working to that end have increased the employee count in Europe, pretty well over the last couple of years, but there's more work to be done there. So I think as we've grown, the European component of our revenues, I think, has that split of round numbers, 60%, 65% revenue in North America with the remainder split pretty evenly between Asia and Europe has stayed pretty consistent. So it's growing, growing as our businesses as a whole. And I think there is opportunity for us to accelerate in some geographies there. [Operator Instructions] There are no further questions in the queue. I'd like to hand the call back to Mr. O'Connor for closing remarks. Very good. Well, I appreciate everyone's time and attention here. It's been a very good quarter for us, very active and look forward to continuing that through the next couple of quarters and look forward to talking to you again at the end of our second quarter. Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.
EarningCall_1409
Thanks, everyone, for joining us today. My name is Scott Berg. I lead the enterprise software and SaaS research efforts here at Needham. Today with us, we have UiPath. We have the company's relatively new Co-CEO, Rob Enslin, with us. Rob, thanks so much for joining us. I guess, how about a brief overview of UiPath, what the company's platform does, for the few people here that might not be familiar? Yes. I mean, the company started in RPA space, and really took off, I would say, around 2017. And since 2017, it did significant amount of investments in a broader space around UI, around automation, in general. So, the platform today -- the UiPath business platform today has three major categories. Discovery, which is process mining, task mining; and a new acquisition we did around Re:infer, which is called communication mining, but think of it as understanding email, understanding sentiment in email, understanding chat, tickets and so on. So, that's all in the Discovery -- in the Discovery process. And then, it has a process called Automate, which is basically low-code/no-code, workflow, the ability to create apps. It's got a studio development environment for citizen developers, for professional developers and so on to create so called automations or bots. And then, it has an Operate capability, where it actually allows you to manage your automations. It's got some significant, I would say, extensions when you look at the market where we actually do things like document understanding, text understanding, the ability to read documents and to process on documents. And then, we bought a test suite, think of traditional tests, regression testing, things that are super exciting in the enterprise space. Test suite to actually do to connect actually automations to testing, so that you could actually scale automations really fast when things change, and allows us to have some significant differentiation with companies. And so, the platform, we are driving the process of defining a category of automation or hyperautomation in this space. And those all the pieces that actually put together. Largely, we see a TAM or traditional TAM market, which we actually defined as roughly 93 billion of opportunity. Gartner has models that come up anything between, I would say, a couple of hundred billion. I mean -- but we see the opportunity is significant. We're going to start talking about the industry a little bit, because I think investors' perception of this industry is still a little bit on the light side. When I first started doing research on you and your competitors several years ago on the space, the one comment that was made to me was every, call it, white-collar employee or higher within a company can benefit from the use of an RPA bot in their corporate life. But can you talk about how broad the use of bots within an enterprise can be? Because I think a lot of investors tend to believe that it's really only regulated to the offices of CFO. Look, first of all, I think it makes a lot of sense in the CFO's office, because it does repetitive mundane task really well, right? So, when you look at any other transaction-based systems, they all end up in the finance posting in the GL. And what you find in the finance -- the things that we can do really well in a finance organization are accounts payable, accounts receivable, invoice matching, invoice splitting, connecting different systems, like signing on to an Ariba system or a Coupa system, creating a split invoice payment automatically and so on to SOX compliance really well generate stock-based compensation. So, there's a lot of pieces in the finance that creates levels of efficiency that CFOs are always trying to go after. So, it's a natural -- it's just a natural opportunity. But when you think about the way that companies have utilized it, and if you look at a couple of our customer cases, they've utilized the platform in a significant way. I mean, I would use a couple of examples, different examples, to give you some kind of an idea. Generali, for instance, the insurance company, been around, I think, 140 years. In the last three years, they've saved €80 million. They have a target to get €125 million -- these are public today, with -- through UiPath Automation, not through anything else, through UiPath Automation. They're doing all of their claims, payment processing automated through our automation. A bot is simply an app. So, we use the word bot or automation. If you look at the New York State, when COVID came, I mean, they processed -- they had to process 1.2 million claims in two weeks, that could not have been achieved by providing humans. They utilized the technology from automation and bots to process it. And through that process, they were able to identify possibility of 12 billion in fraudulent claims, right? So, that's another example. And then, when you look at a media company like Dentsu -- everybody knows Dentsu. They do ads, media, they're fourth largest in the world. And they run -- they basically do automation at the citizen developer process to take away mundane task, so that their creative people are able to spend their time doing creative stuff. So, cut and pay simple stuff when they come to work in the morning, and all their tasks for the day already automated and ready for them to go and they don't actually have to do those tasks. Ernst & Young have over 125,000 automations running today. They do a lot of the SAP work. Their consultant advisory services actually do not want to sign on to an SAP system for a number of reasons. They don't spend a lot of time in it. It's once a quarter or so on, so that they've driven automations to actually build those processes and do the work for them, so they can spend time with their client in advisory services. And then, Uber, I think there's a couple of places I've mentioned Uber a couple of times, when Uber had to bring 460,000 drivers back, they used UiPath to go and do security checks, Department of Transportation makes certain that they're validating, and their view is that they were saving about $2 million a day doing that. So, there're significant use cases in different departments. We are -- when you look at where we have been very successful in the last three years, it's been in banking, financial services, insurance, health care are a couple of the areas that we've been really successful in. Okay. So, from an industry perspective, you have, at least in terms of revenue, one larger competitor. There's a few smaller competitors that… No, not bigger than you. Just larger in general revenue, more than $100 million, certainly not larger than you. Yes, just reasonable size. But there's also a large platform player based out of Seattle that's been trying to get in this space at least… Yes. So, when you look at the RPA environment, I don't feel like -- I think we feel like, in many cases, we replaced Blue Prism, especially in the financial services, in the banking institution on a consistent basis. We had two, we announced in our Q3 results with Bank of New York Mellon and Orica where -- that we replaced the competitive -- and we see that consistently. And that's a case of innovation and technology. We don't see as much automation anyway in the market. We feel, in the RPA space, we continue to take market share from all of them. Specifically, in our RPA space, not in the full platform space, but in our RPA space, we feel like we continue to take market share. Gartner have basically published -- it's probably a year old, but have published that we have 36% of the market share. We're the only one that's growing at roughly 6 percentage points. So, in the RPA space, we feel like we've differentiated ourselves significantly from the two competitors that are in this space by driving the platform play, having UI-type automation at a significantly different level. Then, we have processed mining today, task mining, communication mining. They don't have those kind of technologies in place, so we can actually service a much broader audience than either of those competitors. With Microsoft, we are both partners. We co-opt with them. We do a lot of technology work with them. We made an announcement that we are their preferred enterprise automation platform for their customers. That largely would tell you that the Azure salespeople actually enjoy driving UiPath into their customer base, because we drive significant amount of commits off the cloud platform for them. And they don't have an enterprise platform. So, here, we actually -- we live side by side when they have an ELA-type license agreement in -- the Power Automate and on the Office 365 and customers. But the moment customers want to scale, then they look to UiPath to scale in the enterprise space. Okay. So, let's talk about the UiPath product specifically. UiPath and RPA really began with larger enterprises adopting an on-premise deployment of bots. But last year, you all released your first kind of cloud-native bots, in particular. Can your cloud bots do everything that the behind-the-firewall bots could? Or are there some limitations there, because it's new? No. I mean, they've been developing the cloud-based environment for quite some time. They actually have the same capabilities between the cloud and on-premise. But we actually just -- I mean, we have followed and adopted a policy of -- customer can decide where to drive it, what makes sense for them. When you look at the smaller customers, really clearly, they're driving more cloud. When you look at more regulated financial institutions, they've continued to drive the on-premise version. But customers can also take the on-premise version and there's no reason why they can't run it in a cloud environment, in an AWS, in a Google, in an Azure environment. Our product is built on Azure, right, the full cloud product. And, yes, it has the same. It also -- we also have benefits in the sense that when you have a sovereign environment or you need to position your solution set into a sovereign-type environment where they want the data or they want the thing running in a sovereign environment, we can actually run in a sovereign cloud, which allows us to support governments the way they require those kind of environments, which are quite a few today. Okay. So, what would be the maybe pushes or pulls over a period of time of why more of the market would or would not go towards a cloud deployment -- or cloud bot deployment versus the current on-premise… I have a hundred reasons why I think cloud is, for me, the preferred model, right? I think it's scalable. It's very secure. You have lots of flexibility with it in terms of deployments. And so, I think customers, the same thing. We take away -- from a server-less point of view, you take away a lot of the management capabilities, the need to management, it's all managed for you in that environment. It's a lot simpler and a lot easier to scale. And I think more and more companies will be doing that in the future. I mean, it's just easier to deploy, faster to deploy, simple to deploy in a cloud than it is in an on-premise world. Okay. At your recent Analyst Day that I attended in Vegas, you had a number of new product innovations that you announced that will help expand the TAM to the $90 billion that you talked about: new PaaS, low-code automation platforms, new business process management capabilities. How are these products complementary to your core RPA platform? And how should we think about their growth trajectory relative to what you do with bots? I think it's a great question, right? Because I think -- so if you look at what we said we're going to do at Investor Day, we said we would launch platform pricing, right, which we did. And platform pricing changes the way we price, because we were pricing previously at a line-item level. So, every product was at different sales cycle. It's kind of tough. And we -- with the platform basically gives you capabilities to do all in the management stuff, gives you document understanding, test suite is part of the platform, and ability to utilize that to create automations. So, putting that into the platform, we believe, you need low-code/no-code. You need to have a workflow engine. You need to be able to do integration services through API management. Like you cannot -- in a world of automation, you cannot only do UI, you have to do API, because API is a piece that connects only SaaS systems, SaaS application together, and it's really what's going to drive automation in the future. It's critically important to have the UI piece as well. But those product sets are really important as part of the overall platform piece. And that includes things like process mining, task mining, and our communication mining and automation hub thing. We believe that in the next couple of quarters or months or in the next year, you will see the analysts come up with a very clearer definition of automation and hyperautomation and what companies need to have in this place. We think that we have the majority of those solution sets to create an automation platform. And that's why we actually launched the UiPath business platform at the Investor Day. So, it was very clear to everybody that we -- these are non-line-item. And that actually -- it actually accelerates the revenue growth in our customer base, because they are -- we have fully integrated the utilization and the use of these products together, so that they look like one common environment -- they're all one common environment. They look like one -- they're all one common environment, and you're able to determine which processes you should be automating and which returns you can get. You can actually see in the system. If you automate through process mining, you can go back and look and see what benefits you got. What -- how much of the process is going? How much faster is it going than it was going last year? What kind of improvements you can still continue to do? So, it creates a continuous loop for customers to do automation, and to continue to have automation going. And the companies that have done really well like Generali and Orange have really been doing that for a couple -- I mean, it's not -- we didn't -- they would -- they've been doing this because they figured it out how to do this over time. Yeah. I mean, really, surprisingly positive and it actually changes the discussion we have. So, customers have been interested because when you -- I mean, you've been in enterprise software for a while, you know that over time things consolidate, right? At certain point, best-of-breed solutions become complex to manage because there's too many pieces to it. So, if you look at our UiPath platform, business platform, you could probably plug in 20, 30 different product vendors into that platform. And if you go to many of these Global 2000 companies, they've got 10, 15, 20 vendors running on process modeling, process mining, another one for task mining, something else for testing, right, somebody else for document understanding and so on. You can go through the whole process. And then, they have logs going to Splunk to manage the thing. And it's just very complex for them to manage, and it's very complex for them to bring in a systems integrator, because they don't have somebody that has that kind of skill set. They don't have -- they don't want to bring in 10 people, it's just not cost effective. So, the -- it's been really positive. What companies have -- as we've gone through the conversation, they actually wanted us to prove out that we're good enough. Like, how we -- in our process planning, how close do we get to Celonis? Are we close enough to Celonis, where they'd say, "Look, I can get enough benefit out of UiPath. I don't need Celonis anymore. I'm not going to go down that path. A lot of customers in that space." In the testing environment, it's like, if I can use it for the full automation stack, yeah, then I'm going to replace my existing testing tool. I'm not going to just use you for testing. I want to use you for the whole piece. So, it's been extremely positive in the larger companies, and, I would say, it's been -- we are extremely busy. It's changed our conversation and who we're talking to in many of these companies. Also at your customer conference, I heard of several changes to your go-to-market strategy. Fast-forward, we'll call it, four, five months, have these changes been more subtle in nature? Have they been more significant maybe? And are you kind of through what those changes look like? Because I always think it'd take a sales cycle or two to really take effect. I know. Look, first of all, I think if you're going to do changes and you know what changes you need to do, and you think through it, you got to do as fast as possible, because you want your organization to get stable as quickly as possible. Having an organization constantly in change, creates disruption for a very, very long time. So, we spent a lot of time before Investor Day, validating -- Chris and I came in and we kind of looked at this and we looked and said, you can't continue to sell the pricing the way we're doing. It's just -- it's too complex. Like, we will never find enough salespeople to be able to understand that. And customers are going to just take a long time to buy. Sales cycle is going to be long. And the challenge we had was when we looked at the numbers, like we shared with you our top 25. You look at our investor deck, the top 25 customers, and you can see their scale. But they scale in year three and four and five. Like, we don't want to wait to years three, four and five, we need to bring that way upfront. And so, when we looked at those, like, okay, what do we do really well? We acquire customers really well. Challenges, we acquire them in small departments. We don't scale it well. And the reason we don't scale is because we've got quota carriers that have 40 to 50 accounts. They're never going to have focus. Like, they're never going to focus on where they need to put all eight hours of a day into. So, when we decided to actually do it, we decided, like, we'll make the announcement at Investor Day. We'll run it through the year, and we'll drive the changes as we go through the year and not wait like most companies do to the next fiscal year, [do it okay] (ph), and then next fiscal. We think that would have been so disruptive, because people would have known what we're doing. So, we did it. And we had a good Q3. I think we managed the complexity. We are, I would say, not -- you're never done with changes, but we are pretty much done with the changes. Pricing is rolled out. Solution packaging is part of [indiscernible] thing. All the segmentation has been done. And everybody knows which accounts they're going to have at Feb. 01. We've got new leadership in Europe that's doing really well. And, yes, so I would say you never done, but we are mostly complete with that, and we feel like we got a good handle on the complexity of the changes and the disruption, and we think we've managed the disruption pretty well. But I would also tell you, I think our salespeople initially were very concerned. Like, whenever you take something away from salesperson, they cry, right? It's the first thing. It's, like, "I'm not going to make my numbers." Like, the reality is when you show them what they can do with the platform and the pricing and when you close Bank of New York Mellon and you close HCA and you close Orica at the kind of type deals they are, salespeople then see a different world. And they say, "Oh, I can actually really get significant opportunity inside of my existing customer. And guess what? I know them. I work there every day. I go and knock on their door. I walk down the passage. I know who Johnny is. I know who Shelly is, right? I have [indiscernible] versus all I see is the name on the door. I've never been here. I've got to figure out who." So, there's no way that they will actually -- so our salespeople today, I think, have a much more positive attitude on how they're going to get money, how they're going to drive their quotas, how they're going to get commission in the future. And their task would be like most sales organization, I want the best eight accounts. I want the best 10 accounts, which is natural. Okay, good. On the go-to-market changes, you have a very robust partner ecosystem. You have for several years. You already sell large deals directly. How are you changing, if at all, your relationship or how you interact with partners as part of your overall go-to-market changes? Yeah. We've put a lot of effort into driving more with partners this year, like in different ways. For instance, right at the bottom, we feel like we've expanded our distribution channel with prop -- with distribution folks and now actually understand where their pipeline is coming from and how they're going to get it and why they're getting it still on the distribution side, which is in the smaller market. These companies are good at that. Like, they can afford to close a $10,000 deal and still make money. It makes sense for them and so on. So that part we continue to invest in. The partners that have been around the ecosystem for quite some time, they are mostly local or regional-type partners, they're super excited about the opportunity of presenting a platform and expanding their business, because they know where we're going. So, they're very good in RPA and so on. And in the other partners, we've been working with the E&Ys of the world, the Capgeminis of the world, Accentures, Deloittes, et cetera, because automation is becoming a major category as well for them to drive. And that's very important for us to have global systems integrators that actually can work with the Global 2000 that want to work with them, that have relationships with those type of companies, because that also elevates us up into the C-suite of many of these companies. All right. I'll ask probably two, maybe three more questions, and happy to open it to audience in Q&A, if there are any. The company announced some cost cuts, given the more challenging macro environment. But how do you look at those cost changes relative to your ability to grow? Are you doing anything that might unnaturally change your ability over the next couple of... Yes, we don't want to cut -- this is the way I would look at it like. We said we would drive profitable growth, like, we want to make sure the company continues to grow and I believe there's a significant amount of innovation still ahead of it and innovation should be the way to grow. So, obviously, you don't want to cut your engineering capabilities in a way that actually harms you, hard to get back. I think many folks that know UiPath don't -- probably don't realize that a lot of the loss -- outside of RPA, a lot in the last three years was about getting architecture right for different type of product sets, right? The ProcessGold acquisition required a redo on the architecture to be able to standardize, that's taken a while. That's just -- now we've been able to actually really drive it for process mining and task mining. Cloud Elements, we actually built into an integration, recreate the integration and so on. So, we feel like we've got to a point where there's a lot of technical depth that we don't have, right? And when you look at the revenue streams from a product point of view and a significant portion of the revenue came from RPA and there's a significant opportunity around document understanding, and test suite, and integration services that we actually haven't tapped yet, and those products are mature, and they have customers, and there's a market out there, and we're now positioning it as a platform. So, we feel that's really cool. And then, when we're looking at where we're going with innovation and what we're doing in the innovation spend, we continue to spend a lot of time doing a lot of work around AI and ML activity especially. We spoke a little bit to some of you folks around GPT-3 and what we've done with GPT-3 and what we're doing with OpenAI. I mean, we've been doing that for the last 18 months, and we see that as a significant opportunity in the future. We've also got a lot of research AI folks, David Bader from the UCLA. He's actually working with us directly, because we think that's kind of where the next generation of technology will be headed. And we think automation benefit significantly from that, because we've got some massive levels of information around data, how people use things, what they do with information. And together that with large language models, we think this unbelievable opportunity in this space. So that's where we've gone from a innovation point of view. We haven't scaled back. We -- in many cases, we did not -- in the restructure, we did not cut a significant amount of engineers at all. We actually went to lower-cost locations and things like that. And on the sales side, we feel like we have more than -- we have more of the capabilities to be much more productive with the existing organization that we have in place, that we're going into next year. Remember, our headcount is going to be literally basically flat year-over-year. So, we don't feel like we need investments in -- from a go-to-market point of view, because we feel like we've built a highly-efficient model and an engine that we think we can drive. And if we are successful in the markets that we're going after, we believe we can expand, because we'll be able to invest and pay for that kind of growth going forward. And I'll just add, I think UiPath just over-invested early -- too early in headcount. And so that was an opportunity to make certain we have the right scale and right size. Okay. Last question for me, and I think it's an important financial one over the next couple of years is the company has already guided to a 5-point negative impact or headwind around revenue growth in the year fiscal '24 based on selling cloud versus -- or maybe with some cloud transitions, right? But how do we think about maybe the progression of booking mix between the delivery models more with the bots over the next two or three years? Is this kind of a -- maybe it's five years. Is this a one-time headwind in terms of around -- it's a revenue recognition basis, I get it, it's all short term. But what does that adoption progression look like then... Well, [$215 million] (ph) in ARR now in terms of SaaS, the SaaS portion of model. The pure SaaS portion of the model is relatively small. It's small, right? I mean, it's tiny. And so, we'll have some headwinds on that, but it's not going to be significant, in my opinion. Okay. How do you think about the adoption in other cloud bots maybe over the next three or four years in terms of like a percentage of bookings? I know your larger customers really don't do that, aren't going to adopt that today. But does that change one or two years out, do you think, or this mix be pretty consistent? Yes. I think, really -- so automation cloud with robots is one of our newer offerings that was offered in spring. And so, things like that starting to ramp as we're able to really get the SaaS business going. Right now, we offer Flex SKUs for our customers. So, we give them sort of -- we're agnostic about deployment model and we give them options between cloud and on-prem and they can make into flex back and forth, [custom-made] (ph). And so, that's where the rev rec comes into play. But the SaaS piece is small and it's growing. We've seen triple digits year-over-year this last quarter. Yeah. At the Analyst Day, you guys put out an initial fiscal '24 ARR number, which under new fiscal year '23 ARR guidance implies a pretty sharp deceleration now down to 16% growth. I guess what would have to go wrong for you guys to hit that number? It's a good way to ask that question. We call it an anchor point, right? And -- look, I would say, we were thoughtful in how we position the anchor point to put it out there. I mean a lot of companies don't put it out there. We just decided to put it out there. We took into account that we wouldn't see much benefit out of Europe and the macro situation, and we would have to deal with that. We also took into account that we could have significant disruption from the changes that we were making and so on. So, if you go back to when we put it out and we actually haven't gone back to relook at that model, we'll, obviously, guide when we do the announcement. But that was all built in. We built in more macro issues, tougher macro issues coming out of Europe that we would -- disruption in the sales organization and so on. And so, it was, I would say, a thoughtful anchor point. So that's the way I would look at that. Any other questions? We certainly have time for one or two more. Well, with that, I guess we'll wrap it up.
EarningCall_1410
Ladies and gentlemen, thank you for standing by. And welcome to the NeuroOne Medical Technologies Corporation Corporate Update Conference Call. Today's call will be conducted by the company's Chief Executive Officer, Dave Rosa; and Chief Financial Officer, Ron McClurg. Before I turn the call over to Mr. Rosa, I'd like to remind you that this conference call will include forward-looking statements within the meaning of U.S. Federal securities laws with respect to future operations, financial results, events, trends, and performance, which are based on management's beliefs and assumptions as of today's call or other specified date. Forward-looking statements may involve known and unknown risks, uncertainties, and other factors, which may cause actual results to differ materially from those expressed or implied by such statements. See NeuroOne's corporate update press release and SEC filings for information regarding specific risks and uncertainties that could cause actual results to differ. Except as required by law, NeuroOne undertakes no obligation to update such forward-looking statements. Thanks, operator, and good afternoon, everyone. During our fiscal fourth quarter, we continued to make exciting strides towards commercializing our second diagnostic product line, the Evo sEEG Electrode. In addition, we made substantial development progress with our therapeutic technology, and we increased our financial runway as well. Let's first discuss the progress with commercialization efforts regarding our Evo sEEG product line. We received clearance for less than 30 days use from the FDA in October 2022 for similar indications as our Evo Cortical product line, and now expect to begin the commercial launch with Zimmer Biomet in the first quarter of 2023. sEEG Electrodes represent the bulk of diagnostic procedures performed today due to their less invasive placement by neurosurgeons. Many of these procedures currently utilize a robot to enhance precision during electrode placement. We expect the Evo sEEG Electrodes to be used with Zimmer's ROSA robotic platform in the same manner. The company also recently shipped the initial Evo sEEG limited market release order to Zimmer Biomet and is ramping up manufacturing to meet additional orders for a future full product launch. Moving to our OneRF therapeutic ablation electrode system, we had previously reported that we were targeting completion of animal feasibility studies in the fourth calendar quarter, with the potential to complete the product development by the end of calendar year 2022. As a reminder, the system is being designed to both record brain activity and ablate brain tissue using the same electrode. Currently, two separate hospital visits and surgeries, one for diagnostic and one for therapeutic, are required to treat patients that have seizures due to epilepsy. Combining both the diagnostic and therapeutic functions into one device is intended to save time, cost and contribute potentially to improve patient outcomes. We have also discussed our intent to market both the electrode and radiofrequency generator to offer a complete system to our customers. I also previously disclosed that we signed a partnership agreement with RBC Medical Innovations, a recognized leader in the development and manufacturing of electromechanical therapeutic devices, to develop and manufacture our radiofrequency generator. We have now completed the hardware and software prototypes for preliminary design verification tests on the generator. We also successfully completed animal feasibility studies with the assistance of Dr. Robert Gross of Emory University in Atlanta, Georgia; and Dr. Jamie Van Gompel at the Mayo Clinic in Rochester, Minnesota. Now let's discuss our efforts in developing electrodes that can be used for chronic stimulation and recording. We continue to make progress on the testing of these electrodes that are being designed for use in indications such as Parkinson's disease, epilepsy, back pain due to failed back surgeries, and potentially mental health indications such as severe obsessive compulsive disorder, depression, peripheral pain, and other conditions requiring a permanently implanted electrode that can deliver both diagnostic and therapeutic functions. Our initial focus is to target the spinal cord stimulation market, which currently represents over $3 billion of revenue in the U.S. market. We are designing our devices to utilize percutaneous delivery systems meaning nonsurgical placements, while targeting designs that require less battery energy with expanded coverage of the tissue as compared to current competitive electrodes placed percutaneously. We have also recruited key opinion leaders comprised of both pain specialists and neurosurgeons to help guide in the development of both the electrode and device delivery system. Another area of focus for the company has been the effort to generate pre and post market clinical data to support our technology. In the third and fourth fiscal quarters, the company presented at the Congress of Neurological Surgeons, the Society for Neuroscience, and American Epilepsy Society conferences. We were also included as part of the National Institute of Health submissions with the University of Minnesota to develop a cortical electrode that would with potential assistance from Medtronic plugged directly into a Medtronic pulse generator that could provide both sensing and stimulation functionality built into one electrode. The intent would also be to place the electrode through a less invasive procedure that is typically required to place cortical electrodes. From a financial standpoint, we received an accelerated $3.5 million payment from Zimmer Biomet related to certain milestone events as part of an amendment to our distribution and development agreement. This strengthens the company's financial position by providing greater runway, without having to approach the currently challenging financial markets. Thank you, Dave. We have not yet filed our annual report on Form 10-K for the fiscal year ended September 30, 2022. We will provide the full financial results, when our independent registered public accounting firm completes its audit procedures. As of September 30, 2022, the company had cash, cash equivalents and short-term investments of $11.1 million. We also had no debt outstanding as of September 30, 2022. Thanks, Ron. And looking at the past fiscal year, I'm very proud to highlight some of our accomplishments. We completed a public offering, raising gross proceeds of $13.35 million. We've received a $3.5 million accelerated payment from our distribution partner, Zimmer Biomet related to certain milestone events. We successfully completed feasibility testing of our OneRF ablation system, facilitated by Dr. Robert Gross of Emory University and Dr. Jamie Van Gompel at the Mayo Clinic in Rochester, Minnesota. We completed initial testing for our chronic use electrode platform. We received 510(k) clearance of our second product line, the Evo sEEG Electrode product family for less than 30 day use. We received and shipped the initial order from Zimmer Biomet for our Evo sEEG Electrodes, and we rang the NASDAQ Stock Market closing bell to commemorate our FDA clearance milestone for the Evo sEEG Electrode technology. In closing, the company made great progress in fiscal 2022 in a wide variety of areas, including commercialization, development, and capital raises, which will allow us to continue to execute our plan, with the intent to introduce meaningful advances in electrode technology for a wide variety of neurological applications. I want to thank you for your time and attention. I want to wish you a wonderful holiday season, and I look forward to providing future updates on our progress.
EarningCall_1411
Good morning, everyone, and welcome to the FNB 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 also note today’s event is being recorded. At this time, I would now like to turn the floor over to Lisa Heidi (ph), Manager of Investor Relations. Please go ahead. Thank you. Good morning and welcome to our earnings call. This conference call of F.N.B. Corporation and the reported files with the Securities and Exchange Commission contains forward-looking statements and non-GAAP financial measures. Non-GAAP financial measures should be viewed in addition to and not as an alternative for our reported results prepared in accordance with GAAP. Reconciliations of GAAP to non-GAAP operating measures to the most directly comparable GAAP financial measures are included in our presentation materials and in our earnings release. Please refer to these non-GAAP and forward-looking statement disclosures contained in our related materials, reports and registration statements filed with the Securities and Exchange Commission and available on our corporate website. A replay of this call will be available until Tuesday, January 31 and the webcast link will be posted to the About Us Investor Relations section of our corporate website. Thank you, and welcome to our fourth quarter earnings call. Joining me today are Vince Calabrese, our Chief Financial Officer; and Gary Guerrieri, our Chief Credit Officer. FNB closed strong in 2022, continuing our streak of outstanding performance and is positioned to capitalize on our momentum as we navigate a complex economic landscape in 2020 (ph). FNB's fourth quarter operating earnings per share totaled a record $0.44, increasing 13% on a linked quarter basis and bringing the full year operating earnings per share to $1.40. The success of this quarter was further highlighted by record revenue, continued strong loan growth, disciplined deposit cost management, and the closing and conversion of the UB Bancorp acquisition in December. The fourth quarter's exceptional performance is captured in its strong profitability metrics with operating return on average tangible common equity totaling 22% and the quarterly efficiency ratio below 46%. In the fourth quarter, total revenue grew 10% linked quarter to $416 million with net interest income as the primary driver contributing 13% growth. In addition to benefiting from the Fed rate hikes, our net interest income reflects strong loan growth, favorable funding costs and the strategic steps our team has taken with the asset sensitive position of our balance sheet. Net interest margin significantly expanded quarter-over-quarter from 3.19% to 3.53%. Operating expenses were well managed, increasing 1.5% linked quarter. The revenue growth and disciplined expense management resulted in strong positive operating leverage and an 18% linked quarter increase in pre-provision net revenue. FNB ended the year with nearly $44 billion in total assets and $30 billion in loans and leases, a 5% increase linked quarter. On an annualized basis, excluding UB Bancorp, period end commercial and consumer loans grew 14% and 6% respectively. Continuing a trend, we have upheld throughout the entire year. We saw strong loan growth in markets spanning our whole footprint. Once again demonstrating the importance of our diverse geographic coverage and presence in both mature and high growth markets. The acquisition of UB Bancorp closed on December 9, 2022 with the systems conversion successfully completed and integrated. With the addition of UB Bancorp’s rich deposit needs, which includes 43% non-interest bearing deposits, we ended the year with the total non-interest bearing deposit mix at 34%. This result was in line with the end of 2021, despite Fed funds increasing 425 basis points, demonstrating the strength of our deposit franchise. We are pleased with the financial benefits and dedicated employees in UB Bancorp acquisition has brought to us and expect to generate additional revenue as these customers are introduced to FNB's more robust product set. FNB's impressive fourth quarter and full year results demonstrate our significant success driving value for our clients, communities, employees and shareholders. I'd like to call out a few of our many accomplishments. FNB achieved operating earnings per share of a $1.40, one of the highest levels in company history, led by record revenue of $1.4 billion. Total loans grew by $5.3 billion year-over-year, 21% through strategic combination of footprint wide organic growth and the completion of two accretive acquisitions, bringing total assets to $44 billion. Despite the challenging economic environment, we grew total deposits to an all-time record of $35 billion and reported average balance growth in all four quarters of 2022, while also maintaining a favorable deposit mix comprised of 34% non-interest bearing deposits. We currently hold the top five deposit market share in nearly 50% of our MSAs according to data provided by the FDIC. We generated over $1.1 billion of net interest income, up 24% year-over-year, driven by solid loan growth, the favorable deposit mix and the asset sensitive portion of our balance sheet. Our team controlled expenses in a high inflationary period, which contributed to FNB's full year efficiency ratio of 52%. FNB reported total shareholders' equity of $5.7 billion and a CET1 ratio of 9.8%. Our growing capital base provided our company with unprecedented flexibility even after returning $220 million to shareholders with common dividends and our active share repurchase program, which has $175 million remaining. Our strong earnings also resulted in 40% dividend payout ratio and 34% on an operating basis, providing our company more internal capital to support future growth and capital actions. Credit quality remains solid with consistent prudent underwriting standards throughout the footprint, with total delinquencies ending the year at 71 basis points, net charge offs at 6 basis points for the full year and a reserve position of 1.33%. We will maintain our steadfast focus on our disciplined credit culture as we continue to navigate changing economic cycles. We closed and converted two acquisitions. Howard Bancorp at January and UB Bancorp in December, which have enhanced our market position in Maryland, Washington. D.C. and North Carolina. Driven by our continued investment in FNB's digital delivery channel and our dedicated mortgage employees, the Physicians First Program comprised 25% of retail mortgage production in 2022 and grew those high value households significantly. We continue to expand our eStore platform, which received over 500,000 interactions in 2022, up 104% year-over-year and introduced online applications for multiple consumer loan and small business deposit products. The success of our digital strategy drove increased adoption across our expanding customer base, including a 17% increase and online applications. Our consistent performance does not happen without the right culture and the commitment of exceptional people. We focus on fostering a positive productive workplace where engaged employees provide superior service for our clients and attractive returns for our shareholders. Our success in this regard has led to extensive third-party recognition. Since 2011, FNB has received more than 80 prestigious Greenwich Excellence and Best Brand Awards, with 17 in 2022 alone. These results are based on direct feedback from our commercial, middle market and small business banking partners. Additionally, FNB received approximately 50 awards as an employer of choice, including multiple national and regional honors in 2022. Earning a place is one of Newsweek America's Top Workplaces for Diversity in 2023. And most recently named to JUST Capital's list of America's most JUST Companies for the sixth consecutive year with exceptionally high marks for community development, employee benefits and work life balance. Our board and leadership team are proud of this year's achievements and we are confident in our company's continued ability to execute on our strategic plan in 2023. Even in times of economic uncertainty, we are well-positioned given our diversified loan portfolio, investments in technology, strong liquidity position, capital flexibility and strong historical credit performance. Thank you, Vince, and good morning, everyone. We ended the year with our credit portfolio well positioned and our asset quality metrics remaining near historically level levels. Our performance for the period reflects total delinquency and ended the year at 71 basis points. NPLs and OREO at 39 basis points, rated asset levels remaining essentially flat quarter-over-quarter, excluding UB Bancorp and full year net charge-offs at 6 basis points. I will cover these GAAP asset quality highlights for the quarter and full year in more detail followed by some insight into our credit strategy. We use to manage the loan portfolio throughout economic cycles. And finally, we'll provide a brief update on UB Bancorp acquisition that closed during December. Let's now walk through our credit results. Total delinquency ended December at 71 basis points, reflecting a 12 basis point linked quarter increase coming off on historically low past due levels in the trailing quarters. NPLs and OREO at 39 basis points were up 7 bps in the quarter with nearly 60% of our NPLs in a contractually current payment status. Net charge-offs from Q4 totaled $11.9 million or 16 basis points on an annualized basis with full year net charge-offs for 2022, totaling $16.2 million to stand at a very solid 6 basis point for the year, consistent with 2021 levels also at 6 basis points. Total provision expense for the quarter stood at $28.5 million, includes $9.4 million of initial provision for non-PCD loans that were acquired from UB Bancorp, with the remainder providing for loan growth, charge offs and updated economic forecasts that reflected a softer macroeconomic environment requiring additional reserve. Inclusive of the additional Day 1 PCD gross up of $1.8 million. Our ending funded reserves stand at $402 million or a solid 1.33% of loans at year end. Reflecting our strong position relative to our peers, with the funded reserve ticking down 1 basis point compared to the prior quarter. Our NPL coverage position remains strong at 354%. I'd now like to briefly update you on our recently closed UB Bancorp acquisition and the successful conversion of this $650 million portfolio during the fourth quarter. Our credit and lending teams continued to diligently review their loan portfolio as part of our standard post conversion process following an acquisition. The book remains in line with our expectations from due diligence with no material impact to our overall credit, loan risk profile or portfolio concentrations at the close of the year. We'd like to congratulate the team on closing another successful transaction and will bring additional opportunities to expand our customer base and support our corporate growth objectives in the desirable Carolina of markets. We welcome our new UB Bancorp customers and we look forward to the opportunity to provide our expansive set of banking products and services team as we deepen these relationships. In closing, we had another successful year marked by the continued strength and favorable positioning of our credit portfolio moving into 2023, as well as closing two acquisitions to enhance our presence in attractive markets that will further support our loan growth objectives. Consistent with our proactive and aggressive approach to managing risk, rating credits and positioning potential problem assets, we continue to closely track emerging macroeconomic trends and signs of stress heading into a softer environment. We remain steadfast in our approach to consistent underwriting and managing credit risk to maintain a balanced, well positioned portfolio throughout economic cycle. Thanks, Gary. Good morning, everyone. Now we'll focus on the fourth quarter financial results and offer guidance for 2023. The fourth quarter net income available to common shareholders totaled $137.5 million or $0.38 per share. After adjusting for $21.9 million of merger related expenses and $2.8 million of branch consolidation costs, net income reached record levels of $157 million or $0.44 per share. Full year 2022 operating earnings per share also represented one of the company's highest levels coming in at $1.40. The growth in the balance sheet brought assets to $44 billion with earning assets nearly $39 billion at the end of the year. This was largely driven by the $1.5 billion linked quarter increase in spot loans and leases, which included organic growth of $824 million or 11.4% annualized and the $651 million of UB Bancorp acquired loans as of the December 9 acquisition date. [indiscernible] C&I and commercial real estate each grew 6.3% linked quarter. Consumer loans increased 3.4%, reflecting portfolio growth and adjustable rate mortgages and the continued success of the Physicians First Mortgage Program. Full year total loan growth was a robust $5.3 billion or 21.2% on a year-over-year spot basis, roughly half of this growth was related to the previously discussed Howard and UB Bancorp acquisitions with the remaining half due to strong organic growth capping-off three sequential quarters of double-digit organic growth across the footprint. Average deposits totaled $33.9 billion for the fourth quarter, increasing $301 million or 1% including UB Bancorp acquired deposits over the last three weeks of the year. When excluding UB Bancorp deposits, average non-interest bearing deposits declined only 1% linked quarter $11.7 billion and we maintained a favorable deposit mix at year end with 34% non-interest bearing deposits, demonstrating the strength and granularity of FNB's deposit base. Record quarterly revenue of $415.5 million were driven by record net interest income totaling $334.9 million, a linked quarter increase of $37.8 million or 12.7%. The net interest margin increased 34 basis points to 3.53%, as the earning asset yield increased 62 basis points, while the cost of funds increased 30. The largest driver was increase in yields on loans and leases, which increased 68 basis points. In fact, the December loan origination yield was over 6%, the highest since 2009 and approximately 100 basis points higher than the spot portfolio rate at quarter end. With 59% of the loan portfolio repricing, we expect the portfolio rates continue to increase given the December Federal Reserve rate hike and expected 25 basis point increases in February and March. The fourth quarter also had record positive operating leverage of 29.1% which we expect to rank in the upper quartile of our peers. On the other side of the balance sheet, deposit costs continue to be a significant focus for our team. Total cumulative deposit betas ended the year at 16.3% below the forecasted 20% by maintaining the previously mentioned favorable non-interest bearing deposit mix and actively managing interest bearing deposit costs. We were able to keep the average interest bearing deposit costs below 1% for the fourth quarter again demonstrating the strength of our customer relationships. We have been able to effectively manage deposit costs, strategic pricing campaigns supported by our data analytics platform. While competitive pressures on deposit pricing continue to rise, we are forecasting a cumulative total deposit beta to be in the low 20s at the end of the first quarter of 2023. Turning to non-interest income and expense. Non-interest income totaled $80.6 million, a decrease of $1.9 million or 2.2% compared to the prior quarter. Mortgage banking operations income decreased $2.4 million with a decline in mortgages sold in the secondary market and lower gain on sale margins. Insurance commissions and fees decreased $1.3 million reflecting seasonality in the fourth quarter. Capital markets income totaled $10 million with this strong level supported by an increase in syndications and solid contributions from swap fees and international banking. On a full year basis, non-interest income totaled $323.6 million, a 2.1% decrease from 2021 primarily reflecting a significantly lower mortgage banking operations income, which was partially offset by several other fee based businesses, again demonstrating the importance of our diversified business strategy. On an operating basis, non-interest expense totaled $195.8 million, a 1.5% increase from the third quarter and an increase of 8.3% from the year ago quarter which is primarily driven by the acquired Howard and Union expense basis in occupancy and equipment and outside services. Other non-interest expense increased linked quarter primarily from charitable contributions during the quarter to qualify for Pennsylvania bank shares tax credits. Salaries and employee benefits decreased from the third quarter due to lower medical costs and seasonally lower production and performance related incentives. Excluding significant items totaling $52.3 million in 2022 and $4.4 million in 2021 full year operating non-interest expense increased $45.4 million or 6.2%. Fourth quarter's operating pre-provision net revenue totaled a record $219 million, representing an 81% increase from the year ago quarter. On a full year basis, operating pre-provision net revenue was $669.2 million, an increase of 31.7% in 2021. Our capital ratios ended the year at levels that are expected to be at or above peer median. Tangible book value per common share was $8.27 at December 31, an increase of $0.25 per share from September 30, largely from the higher level of earnings and the decreased impact of AOCI by $0.09 per share. CET1 ended the year at a solid 9.8% and the TCE ratio totaled 7.24%. Let's now look at the 2023 financial objectives, starting with the balance sheet. We expect loans to increase mid-single digits on a year-over-year spot basis. Total deposits are projected to end 2023 at a similar level as of December 31, 2022, spot balances as customer growth continues alongside active management of deposit rates in an environment with rising deposit betas. Full year net interest income is expected to be between $1.34 billion and $1.4 billion, with the first quarter of 2023 between $335 million and $345 million. Our guidance currently assumes 25 basis point rate increases in both February and March with no additional rate actions projected for the remainder of the year. Full year non-interest income is expected to be between $300 million and $320 million with the first quarter in the mid $70 million range. Full year guidance for non-interest expense on an operating basis is $830 million to $850 million, which assumes an additional $8 million in FDIC deposit insurance costs, reflecting higher assessment rates, it may remain in effect to the deposit insurance fund reserve ratio meets the FDIC's long-term goal of 2%. This expense guidance range implies growth of 7% to 10% and full year 2022 operating expense figures. At the midpoint of our guidance, the efficiency ratio would be below 50% for full year 2023. When excluding the FDIC increase in the Union acquired expense base, the 2023 expense range would be 4% to 7% on a year-over-year basis. The first quarter non-interest expense is expected to be between $210 million to $215 million as the compensation expense is higher in the first quarter, largely due to normal seasonal long-term stock compensation and higher payroll taxes at the start of the new year. Full year provision guidance is $65 million to $85 million and is dependent on net loan growth and CECL model-related builds from a softer macroeconomic environment. Lastly, the effective tax rate should be between 20% and 21% for the full year, which does not assume any investment tax credit activity that may occur. Thanks, Vince. As we start the new year, we remain focused on executing our strategy and serving our stakeholders. We will do this by staying true to our values based culture. And delivering on the financial guidance Vince provided with a focus on generating positive operating leverage and efficiently deploying capital in the most effective way to optimize risk adjusted returns for our shareholders. Before we close today, I want to recognize our dedicated team, who made our performance positive. Every employee contributes to the success of the company, and I strongly believe that we will continue to win at FNB because of our outstanding employees and the excellent culture we have developed together. Ladies and gentlemen, at this time, we'll begin the question-and-answer session. [Operator Instructions] And our first question today comes from Frank Schiraldi from Piper Sandler. Please go ahead with your question. Just curious you guys talked in the release a little bit about where you saw the strongest growth geographically. And just curious if you can give a little more color there, specifically on the -- what percentage of the commercial growth you're seeing coming out of the Carolina footprint. Yeah. I don't know that we have the specific – specifics in our finger tips, but I can tell you just from what we get, the Carolina has had an exceptional year. They contributed throughout the year in [indiscernible] all of those areas were big contributors to loan growth. They all exceeded their planned objectives for the year and had a tremendous year in cross-selling. So in addition to eliminating loans that are also able to cross-sell capital markets, products, trust and investment products and insurance throughout that footprint. So they were a significant driver. Pittsburgh has always been a solid market for us given our market share here. The groups in Pittsburgh were [indiscernible] this year. And I also want to include our expansion market in Charleston. The team down there has done an exceptional job over the last two years and [Technical Difficulty] the last two years. So those areas have been huge contributors. In the past, the Mid-Atlantic region has been a fairly substantial contributor, but we were able to -- through various takeouts, reduce the size of the seating portfolio in that market. So we had a little bit more of a headwind coming into the year. And I will tell you that as we move into next year, the pipelines have softened a little bit kind of globally, but we had two consecutive quarters of pretty solid growth. So we're down about 15% year-over-year, with the pipeline typically a seasonal low point. And we're being a little more careful as we move into next year, quite a bit of economic uncertainty and player conservative side. So very excited about where we sit, though, Frank, in terms of originations because it was barely geographically spread out. We got some assistance from the Midwest and the Northeast with -- in some of the slower growth markets because they have a heavier industrial base, and there seems to be a little more activity there to offset some of the declines in CRE opportunities in the Mid-Atlantic region. So it all kind of balanced out. And I think as we've said all along, that has been our strategy to have a very longs to grow. Sorry, actual on the portfolio. That's great. Thanks for all the color. And then I just wanted to follow-up on the guide, specifically on fee income. It seems like -- I don't know, even if I can sort of normalize the other line item this quarter, maybe you get the mid-70s number you're still sort of at -- already at sort of the midpoint of that run rate guide for next year. And so just kind of curious if you can provide any puts and takes in terms of where you might see some growth in fees and where we could see some further weakness in 2023. I could comment, Frank. Just I guess, high level, non-interest income was solid again at $80.6 million for the quarter, down slightly from the third quarter. Mortgage banking income coming down. $2.4 million, there's kind of normal seasonality there. One thing I did want to point out too is that it's important, the growth in the balance sheet of adjusted for rate mortgages has been higher. We've been portfolioing more loans that we might otherwise have been selling in the past. So the fee revenue is a little bit lower on the mortgage banking side. No capital markets for the quarter, very solid at $10 million. We had a higher contribution compared to the third quarter, partially offsetting that reduced contribution from mortgage and the second consecutive quarter with strong syndication fees. As you look ahead, some of that revenue sources are lumpy like the syndication fees are always consistently at the same level, they kind of come in lumpy, the swap piece also can be a little bit lumpy. So, us guiding to mid-70s again, which is what we guided to for the fourth quarter is really just kind of a function of that as well as we made some changes to consumer deposit fees that we had announced in November. That's also kind of rolling through the numbers. So it's kind of a conservative look, I would say, based on kind of what we know today. But the lumpiness you can't predict with certainty as far as some of the kind of capital markets component. So that's why the guide at that kind of mid-70s level. Hey, Frank. So Chris [indiscernible] on the Carolinas, over the last three years, the Carolina markets, both and South Carolina produced roughly 40% of our net loan growth. Okay. Great. [Multiple Speakers] No, I appreciate that. And then if I could just lastly, just you're getting closer and closer to that 10% CET1 ratio -- and just wondering if any sort of strategic changes we can expect when you do reach that level and pass through it? And I guess, specifically wondering about additional capital return if this could trigger greater buyback activity as we move through 2023. Thanks. Yeah. I would just say, we expect to build a 10 in the near term here, given the level of earnings that we've been generating really creating that capital flexibility we've never had in the past. So we got [Technical Difficulty] buybacks. I mean our first and best use of capital, as we've said all along, the strategy is the same as to deploy it into loan growth. So depending on how strong the loan growth is or how much it slows down, you'll have more opportunity to do buybacks. So it's clearly on the table for 2023. As you know, we remain committed to managing capital in a way to just fully optimize on shareholder value fully aligned with shareholder interest. So we will be looking at that. We'll be opportunistic as we go through the year. I think in total, we have about $175 million or so of capacity remaining in our former program. So clearly, as we expect to build past that 10% level, the share buybacks are definitely something we'll be pursuing and evaluating on a daily basis. Yeah. Maybe starting with Vince, your comments on utilizing analytics to help drive the deposit base. Can you give us some examples of how you're doing that and your deposit performance has been really strong, your beta among the best in the group so far. I guess -- how are you getting that and is that going to be a sustainable level or a sustainable avenue of growth as we go forward. Yes. This is Vince Delie actually, Steve mentioned that in his comments and I will tell you, we've made a significant investment in our ability to analyze large quantities of data. We've talked about that before. We have the data. We have an entire team that manages the governance and systems. We've invested early and heavily in that area over the last five or six years. We use that team to basically give us a better understanding of the types of clients that we have and to really drill into client behavior expectation and it enables us to be able to provide them with better solutions. And the answer on the deposit stability and growth, I think we're an outstanding deposit franchise. I think if you look at the mix, the mix is very strong relative to the peers. The stability of the demand deposit base is very strong. The granularity is strong. So there's quite a bit that goes into managing a deposit portfolio of that size. There's not just one silver bullet. So we focus -- we use analytics to focus on treasury management opportunities within our customer base. We use the analytics to view customers that are single source or single product customers that may have a loan product that don't have a fuller depository relationship with us. We use the analytics tool to tier the clients based upon need that helps us direct our resources more effectively to drive growth. We also use the analytics tool with our digital offering so that we can present products and services to clients as they engage the eStore online. I mentioned in my comments, we had 500,000 views on the website and on the mobile app because our eStore is embedded into our mobile application. So it's right there for the customers to engage with, that -- all of that helps us manage the betas and the deposit outflows and deposit growth and the mix of the deposits. So it's a pretty complex set of strategies that we deployed and the tactics that underlie the strategy in each segment really are geared towards driving better performance in that deposit portfolio. Hopefully, that answers your question. That's pretty flat [Multiple Speakers] That was great color. Maybe looking at margin, you project or you expect a couple more 25 basis point hikes. What's your expectation for DDA diminishment in that scenario? And are you taking any steps to protect margin if we start shifting to more of an expectation for lower rates in the future? Yeah. I would start with just the non-interest bearing deposits, again, are a big focus in the company. So our ability, as you can see here in my prepared remarks, I mean, EAs were down 1% or so less for the quarter that takes a lot of effort. All the tools that Vince talked about analytically as well as our team on the front line and our relationships with customers that are very strong. We've created a lot of goodwill going to PPP. We're in that process with existing customers and new customers that we've been broadening relationships with. So that -- those relationships and our customers' willingness to talk to us and if they're looking to move money instead of just moving money is very valuable. And our team on the front line has been very active throughout the fourth quarter. Talking to customers. We have a large corporate initiative that's been on the lending side as well as the deposit side. That has been bearing fruit during the quarter. So our goal is to sustain the DDAs and continue to grow them from here. We have a slide in there that shows a percent of full deposits from 16% up to 34%. Our team is incented to work hard to grow those non-interest bearing deposits. We have a lot of tools in place, but why don't you mention also our active asset liability strategy, a focus on preserving margin. Yeah. I would say we as you would expect, I mean our treasury team studies at daily. I mean we've been looking at hedging opportunities really for the last year, and we did some small amounts of hedging, I don't know, six months or so ago, but decided not to put more on because of where levels were and what was expected to happen with rates. You don't have to go back that far when everybody was locked in that rates are just going to fall off a cliff one quarter or two quarters into the year and then the protection and that became very expensive. So we've put some on. Naturally, our asset sensitivity has been kind of approaching neutral. If you look at the asset sensitive our interest rate risk position, you're down to like 1% or so for plus 100, minus 100. So organically, it's been kind of coming down as we've been deploying cash just kind of the natural movement of the balance sheet. So we'll continue to monitor it, Jared. But at this point, the price points haven't made sense to us to load up on hedges for the balance sheet. But we'll continue to look at it and we'll be smart about it when it makes sense. And if it does make sense to us, we'll put something done. We've done about $1 billion or so of received fixed swaps over the recent period. So we have that component there. But the natural asset sensitivity coming down, and as you know, net interest income is at a much higher base. So it's kind of coming off of that. So having that lower interest rate risk a more neutral interest rate risk position is a positive and as we move forward. So we'll continue to monitor as we have and evaluate any hedging opportunities that make sense. But the main deposits are always valuable and in this environment, we're even more valuable. So our team's success in growing those non-interest bearing deposits, which is key for us, and that will always be a focus. Okay. Thanks. And just finally for me, just on the capital management side. What's the appetite for M&A here? And maybe, Vince, what's your view of sort of the current state of bank mergers overall? But I think I wouldn't want to be an investment banker in the short run here. I think it's been a pretty challenging environment. Investment banking fees, in general, was down 20%, given what's happened with AOCI is that level it becomes very challenging to do a deal that's accretive that doesn't have substantial relevance to it. And we've stated repeatedly that we're not interested in diluting tangible book value. We have as Vince said, we have capital flexibility that we've never had before, which could mean a number of things and we did become more aggressive in buying shares back if loan growth slows, if you look at the dividend payout ratio on an operating basis, we're down to 34% unheard of it. I mean we took the reins here 80% -- 70%, 80% payout ratio. So we have incredible flexibility moving forward. We want to make sure it benefits our shareholders. So our focus is just driving shareholder returns and making sure that we're making smart decisions with capital so that we can move the stock price up and repatriate appropriate levels of capital at some that's the strategy moving forward. Jared, just to go back on the interest rate risk. On Slide 11, we did add a chart there that shows the interest rate risk sensitivity over time and you can see kind of how it's moved down. We have plus 200, plus 100 shot. You can see how it organically has come down close to neutral by the end of the year, point that out to. Yeah. Thanks. Good morning, everyone. Question on the funding strategy. So the guide outlines about $1.5 billion of loan growth with deposits flat. Just wanted to understand what's the outlook for funding that loan growth, be it bond book or borrowings? Yeah. I would say we still have some excess cash, Casey, to put to work. So we'll deploy that as we go through the year. I think if you look at the loan-to-deposit ratio, what's in our guidance and kind of in our plan, we get down to maybe 90% -- or up to 90%, 91% by the end of the year, which is still a very comfortable level for us. So a combination of deploying the cash, and we might have some small level of borrowings as we get towards the end of the year. But overall loan-to-deposit ratio, very comfortable with those levels. Okay. Very good. And just I guess as a follow-up to that is, what is a comfortable mid-cash position for you guys as well as what is too high a loan-to-deposit ratio? Well, I mean in the past, I remember when we got up to about 97%, we started to get uncomfortable. And we took some actions at that point, some promotional CDs open and those types of things to kind of bring it down. So I'm not saying that's the level, but our prior history, that was when we decided to start doing things. So I think if you got up to 95-ish 97, and we would you look at other options or strategies we should deploy at that point. We have many tools at our disposal to drive deposit. The question is, how much margin you want to give up in this environment. Casey, just to clarify, Casey, I don't have a figure in front of me. So there's $1.2 billion if you look at our balance sheet at the end of the year of interest-bearing deposits. So that cash being deployed to support the loan growth would be the [indiscernible] would go. Yeah. Understood. Okay. And then apologies if I missed it. Any updated Cume beta is coming in very nice surprise positively versus what you were expecting this year. Any updated thoughts on where Cume beta ends up? Yeah. In my prepared remarks, Casey, I mentioned kind of low 20s at the end of the third quarter. And if we look at kind of overall, I would say, well, a few comments on betas, right? I think our team has done an admiral job in the field strategically managing interest-bearing deposit costs. While we're building non-interest bearing. It's a lot of effort, as you would expect. It's daily effort talking to customers, managing the relationships, being smart about rating rates for customers that have kind of full relationships. So it's been a very active process. It will continue to be an active process for us. We ended the year, as you saw on the slide, 16.3 getting down into the low 20s by the end of the first quarter. And then if you look at kind of the midpoint of our guidance by the end of the year, kind of cumulative total beta will be in the high 20s is what we're kind of projecting as we sit here today versus about 24% in the last hiking cycle. Okay. All right. Just last one for me, maybe one for Gary. So the provision guide of 65 to 85. You guys do mention a softer macroeconomic environment. We're all kind of struggling with CECL modeling. Just wondering if any color on and you can provide on what -- how softer that macro is, be it unemployment rates, GDP, et cetera. Yeah. It's pretty much across the board, Casey. And during the quarter, we also saw some softer economic forecasting in our CECL models, which impacted the provision to the tune of about $8 million. So we've got that built in through 2023. So that is a pretty good portion of where we've guided to across the year. The other naturally is -- the other naturally is loan growth as far as the driver there. And loan growth we'll move those numbers a little bit within that range, as we've talked in the past. Sorry, I just wanted to clarify that last comment, Gary. Did you say that $8 million reserve build is what was built into your assumptions for the 2023 provision? Okay. I apologize. All right. Terrific. Do you have a thought on kind of how much reserve build is in the guidance relative to what would be just loan growth or charge-off activity? Okay. All right. Thank you. And then maybe we could just talk a little bit more about the margin. I know we've talked a lot about deposit betas, but just interested in your thoughts on actually the pace of the margin. We can kind of back into what the rest of the -- what the 2023 would look like based on your guidance, but just interested in terms of, if you do continue to get expansion in the first quarter and kind of how much -- how accelerated the contraction you're expecting after that point would be? Yeah. I can comment on that, Dan. The outlook just to restate again, includes an additional 50 basis points of hikes in February and March and then no additional Fed actions for the rest of the year. Our guidance would imply a slight increase in margin from the 3.53 level that we were at in the fourth quarter, peaking maybe the second quarter and they're based on what's in our plans, but we're talking single digits of basis point movement there. So there's still some upside to that level. And then similarly, on the other side, it comes down a little bit from that peak, but we're tucking in the single basis point type level. So that's what's baked into that. Okay. Great. I appreciate. Okay. Terrific. And then I just wanted to again clarify an earlier comment. I think you said the midpoint of your expense guidance would assume that you or would be under 50% efficiency ratio in 2023. I just want to make sure that, that's what I heard. And if there was kind of a -- I had an original question, like how likely you think it is that you do stay under 50%. So I guess assuming your expenses come in about where you expect -- you would expect that to be under 50% is an accurate statement? Yeah. Using the midpoint of our guidance kind of across all the different categories, that's you're very right. That's an accurate statement. Okay. And is that kind of becoming a longer-term goal for the bank to stay under 50% efficiency ratio or if we get into a lower rate environment, do you think that might drift back over. I would say our goal would be to continue to reinvest in the company. And with the changes in the margin based upon macroeconomic factors, it could swing back and forth over 50, under 50. But I will tell you that there will be capital investment required as we move forward, particularly in technology for us to stay competitive, for us to maintain margins in the future and to keep doing what we're doing with the betas and it's not a pre-pass forever. So we have to keep watching what we do, and we're going to have to manage the margin. We're in a very good period for our organization and our -- for this time, we're benefiting. But obviously, the world is going to change. So we diligent on expense control, and we continue to reinvest in the help. Sorry, I didn't. No, no, -- that's good. I would just add to that, I didn't mention the kind of cost savings targets for 23, which is $9 million. As you know, we're a disciplined manager of expenses continue to invest, as Vince said, in a variety of initiatives on the digital side and de novos and some of our kind of digital infrastructure. And then one other thing I would add, in the past, I've talked about kind of project improvement process improvement, I should say. We've always had a focus on that, renegotiating with vendors, facility space optimization. But the process improvement side of it, we've recently reorganized a little bit internally, adding some additional resources to drive the corporate-wide focus on process improvement. I think there's a lot of opportunity deploying RPA type technology to really drive further efficiency as we go forward. And we're still in the early stages of that, but that also will contribute to, I think, allowing us to have sustainably in the low 50s as you move forward, given all those efforts. Hey. Good morning. Thanks for taking my questions. Obviously, you guys covered most of it. Just a couple of quick ones to wrap this up here. Just, Vince, in terms of the kind of geographic footprint, you mentioned a little bit about some pipeline and some stuff like the Carolinas, et cetera. But just as we look at kind of the bank today, any opportunities or areas of focus for you guys in 2023 that we should be mindful of, maybe something like Philadelphia, where there's been a lot of mid-caps taken out over the last couple of years. Just anything kind of like that, that you guys -- that's on your radar that you would convey to us at this point? Yeah. I mean I will tell you that we have studied Philadelphia from a commercial lending perspective. We do have an office there. Our plan is to continue to expand it. We think there's some opportunity there in the middle market, large corporate space. I also think Philadelphia, when we ran our model we looked at MSAs because of the number of companies domiciled there, and the competitive climate. It's score now pretty high. The dynamic keeps changing. There are fewer competitors, right? Basically, we're seeing it as an opportunistic area to expand. And there are several other markets that we launched into that will continue to boot. We've had tremendous success in Charleston. Our plan is to continue to grow there. We are looking at de novo expansion in Richmond. We've studied opening a loan production office commercial only and Atlanta. And those are pretty much the areas that we're focusing on, but nothing earth shattering or there's no movement retail de novo expansion. But I think there are opportunities for us to extract additional high quality growth in our existing footprint, where we may not have the density. And then the other thing that we've done strategically was substantially increased our ATM rollout. What we found is that that's helped us immensely with the retention of customers growing DDA, [indiscernible] expanding small business opportunities. So we've done that through both branding opportunities and direct placement of ATMs and ITMs. So our ATM network grew more than 30% across our footprint. So we have 1,200 ATM locations. So 250 of those were rolled out in North and South Carolina and then another 250 in Maryland, Virginia and Baltimore Washington D.C., Northern Virginia. So we're trying to supplement our physical delivery channel and for branches with other channels to distribute cash and then we're marketing our eStore which enables individuals and small businesses to open accounts online. Anyway, that's the strategy. And I think from a geographic perspective, there's plenty of opportunity within our existing footprint for us to continue to grow. Yeah. I mean, that makes sense. So from the outside looking at it would seem like, especially around the 95 corridor, like Virginia, like you mentioned, Philadelphia, like there -- a lot of the competitors there, though, are much more loaned up right, probably a lot less willingness to lend, deposit betas are a lot higher. The balance sheets are a lot smaller. It would seem like you guys have a pretty attractive value proposition for some lending talent in those markets coming from the West and South as opposed to coming from the New York area where there's just more balance sheet constraints? Yeah. And I think our treasury management offering, at least as it scores out through [indiscernible] and other surveys is pretty well respected. So that enables us to go in and garner deposits as well. We go in, we become the principal bank. We get the operating accounts in cross-sell treasury management services. And I think we've proven moving into the Southeast that our products stand pretty well if you look at the non-interest income growth of the company, a lot of that was driven from our expansion into the Southeast. And there was quite a bit of skepticism about our ability to compete. I think we've put that to rest. If you look at the growth in various categories, it's been fairly substantial and it's been very robust. So we have the product capabilities as well to go into some of the markets that we don't have density within our existing seven states footprint. Great. Thanks for that. And then just last for me, just on the effective tax rate guide, it says assumes no investment tax credit activity, can you just remind us quickly what the activity looked like last year? And just also if you do move forward with any transactions there, what you guys typically look at from an opportunity standpoint? No, I would just say, I mean, it's a line of business for us, but we don't have some transactions each year. I mean, in '22, I don't think we had one in '22, we had maybe a couple in '21. So I mean there's an active business process there, and we may have some this year. We just don't want to put it into guidance if we do, then it's a positive additive to the guidance there. Renewable energy tax credit typically sold may have a long gestation period. So there's a long -- it takes a lot of time to get to the finish line. So even some supply chain issues with the solar panels. So that's elongated some of those projects. Hey. Good morning, guys. Congrats on nice quarter [indiscernible]. Just one clarification. I think it was Vince D, you mentioned the pipeline is just -- can you -- I guess, was it 15%? I'm not sure if you were speaking more to the commercial, the consumer. Just give us an update on what those pipelines. I know they're a little bit softer, but just connecting the dots here just now whether it was commercial or consumer and just kind of how they're trending here. This is Vince Delie, and I was speaking specifically to commercial pipeline, non-consumer. So and what I said we had two very strong quarters in terms of production that tends to have to reset. We're moving into a slower seasonal period, so our pipelines are down. And given all of that, when you look at it on a comparable basis, taking seasonality out of it, we're still down 10% to 15% and the rebuilding -- and they're rebuilding the pipeline. That's just something that illustrates where we are economically. I think there's a lot of uncertainty, I think, our borrowers are on the sidelines for a little bit here to see what happens, right? And it's going to be a little while until we start to see that build back. Yeah. Consumer pipelines, there's seasonality there as well. So it's kind of tough to say. I think the pipelines in general have been pretty consistent with where they've been seasonally, maybe down a little bit. Mortgage, there's more production coming online. In terms of opportunities for us to take on adjustable rate mortgages on our balance sheet. So we're seeing growth in that category. Direct consumer, we're seeing a little bit of lowness in the [indiscernible] space now. But that tends to build back up again as we move through the normal housing sales fees on the home improvement season starts to pick up here at the end of March. So it's a little tough to tell small business is up. Small business is up pretty much across the board. We have some good momentum the number of markets that we've entered. We have a fairly sizable portfolio there to the total bank. It's not – yeah, it’s over a $1 billion, relative to commercial foot [indiscernible] but we are seeing some really good positive momentum in the Carolinas and the Atlantic region. Thanks for the color. Maybe just one or two other, just on the inside the guide on the fee income side. Just kind of your thoughts on mortgage, obviously being kind of a low point for the year and sort of just trying to -- as you think about next year, I guess, can you give any thoughts just on high level on how you're viewing the mortgage activity given kind of what we saw throughout the year? I think I'm going to turn this over to Vince in a minute that I think -- basically, the mortgage business, we've always kind of tracked globally what the expectations are from a number of statistical sources that tells us where the world is expected to be. We tend to do a little better not a little better, we do a lot better than what the typical forecasts are. So I attribute that to the geographic dispersion of our originators. We've had great success in certain segments as well Physicians program that we had that portfolios now grown substantially over $1 billion. So there's little pockets that we go after, but there's also certain markets that tend to have better housing markets generally than our legacy markets like the Carolinas and the Atlantic region. Where we have originators dispersed. I think we'll probably outperform the market overall again this year, I would expect that I think that the servicing portfolio that we have has been a good hedge for us from an earnings perspective. So that's helped us but go ahead, Vince. You've had a couple of others back. Yeah. I was just going to kind of add to look at production overall for the fourth quarter, $967 million, seasonally down in the third quarter, but now 16%. So [indiscernible] to Vince's point, the high-level industry forecast right now is for production originations to be down 24%, baked into our expectations and our guidance is more like a down kind of 14%. So we would expect to outperform the industry like Vince said and we have done that in the past, and we continue to do that. Got you. Okay. So a little bit lower. You're talking about 14% year-over-year is kind of what you're looking at there, right, Vince? And just one more thing. I mean, with the lowering of the 10 year interest rate, we have seen a pickup in lockup volume in both mortgage and in the consumable, just saying that. Yeah. No, that make sense. And just to remind me, I guess, on the deposits, there's been a lot of talk about the beta. What did you guys exit the quarter on the cost of deposits? I guess I know you talked about the betas where they tried to, but for like the month of December, where were the -- I think you said loan yields were I thought they were 6% for the quarter on the origination yields, but the cost of deposits as far as exiting in December, where were you guys there? Got you. Okay. Perfect. And last one for me was just on the deposits. You guys talked about the guide being relatively flat, just the mix. I mean, I know you talked about the work it takes to keep the deposits where they are. Just where you are now on the DDA as you kind of look throughout the year? I mean, do you expect that number to come down a bit? Is that kind of in your forecast or I guess do you think the efforts you guys have -- you can kind of maintain this level you've reset to? We're going to work hard to maintain and grow that in source of funding for us, honestly. I mean there's been some mix shift into CDs as you would expect, more particularly in the municipal and commercial side. I mean there's been some shifting into CD. The key is that it's still kind of staying in the house. So it's moving around a little bit. And the non-interest bearing deposits, like I said earlier, it's a big focus in the company with existing clients, but also bringing in new clients. But you -- really, we have to see how things play out throughout the year. I mean, there's going to be pressure on non-interest bearing deposits with [indiscernible] in the existing book as we move into a period of extended high rates, Brian. So we're going to have to work really but I think we've outperformed at least what we've seen reported recently, and we're going to keep doing what we're doing to maintain those balances to the best of our ability because that really drives our profitability through the mix. You are right. And you're at a much higher base now with all the efforts you guys have had here over the last year or two is the money you've taken in. Hey. Good morning. Most of my questions have been answered, but could you just give me a reset on the Physicians First Portfolio? You said it's about just over $1 billion, kind of like the year-over-year growth? What are like new loans coming in on? Any kind of extra color there would be great. I'll start out with the program itself, so you understand. We have a dedicated team that originates mortgage loans in the space. They've done a terrific job. We've built out on our eStore platform a digitized product offering the bundles, a set of products for physicians. So that's been offered electronically on the eStore and we use that the eStore to promote the product digitally and we've done very, very well. I mean I can tell you the CAGR on this portfolio is, it's fairly significant, 65% since we started 2018. So it's grown nicely. We started with the originators first and then we supplemented their effort with the digital offering and set up the campaign. If you just look at households with physicians, we're up 66% in Eastern North Carolina and the Mid-Atlantic region alone. So we've had some good success in those market. The full year production was over $0.5 billion. It's been -- the portfolio stands at $1.2 billion at year-end. So the program has worked very well for us, and those are high-value households in that we feel confident that with our digital capabilities and our analytics will be able to continue to penetrate that household with additional products and services. So it's a good program for us. The credit quality is stellar in that portfolio. We're also rolling out as we speak, the small business side of that equation for the physician practices. So that's something that we're working to as we speak, and we'll start to see some activity there as we get into 2023, this guidance base growth low. And ladies and gentlemen, with that, we'll end today's question-and-answer session. I'd like to turn the floor back over to Vince Delie for any closing remarks. Well, I'd like to just thank everybody for your interest and the good questions we had today. It was a tremendous year. We really hit on all cylinders. I think the company is in a really good position moving into this year, and that doesn't come without a tremendous effort from our employees. So I'd like to thank all of our employees and executive leadership team and the Board of Directors for their support and confidence. I think over the last four or five years, we've proven that we can execute on a number of levels, and this company keeps exceeding my expectations in terms of what we deliver and what our employees deliver in the field. So I want to thank them and thank our shareholders for sticking with us and supporting us and we're really looking forward to the coming. So no matter what the challenges are, we're going to get there and we're going to win together. So thank you very much. And ladies and gentlemen, with that, we'll conclude today's conference call. We do thank you for attending. You may now disconnect your lines.
EarningCall_1412
Thank you for standing by. Welcome to AT&T's Fourth Quarter 2022 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. I would like to turn the conference call over to our host, Amir Rozwadowski, Senior Vice President of Finance and Investor Relations. Please go ahead. Thank you, and good morning, everyone. Welcome to our fourth quarter call. I'm Amir Rozwadowski, Head of Investor Relations for AT&T. Joining me today on the call are John Stankey, our CEO; and Pascal Desroches, our CFO. Before we begin, I need to call your attention to our Safe Harbor statement. It says that some of our comments today may be forward-looking. As such, they're subject to risks and uncertainties described in AT&T's SEC filings. Results may differ materially. Additional information as well as our earnings materials are available on the Investor Relations website. Thanks, Amir, and Happy New Year, everyone. I appreciate you joining us today, and I hope you enjoyed a restful and healthy holiday season. And at the conclusion of this call, I'm declaring the statute of limitations on this being the New Year has run out. I'll share upfront that our commentary is a bit longer than usual. However, we thought it was important to provide a bit more clarity on our business today, primarily our fiber strategy since we haven't had an opportunity to discuss our December Gigapower joint venture announcement. Still, we'll ensure we have enough time to get to most of your questions. As I reflect on not only this past year, but the past 2.5 years, it's clear that our teams have worked diligently to refocus AT&T around a connectivity strategy that has simplified our company and positioned it for sustainable growth. Our results over the past 10 quarters demonstrate we are on our way to delivering the full promise of the strategy. We're operating a streamlined and return-focused business with an improved profit trajectory that's committed to generating sustained cash earnings growth while delivering an attractive dividend. Underpinning all of our actions is a deep desire to connect our customers with greater possibility through 5G and fiber. And importantly, we're assembling the right assets, talent and capital structure to offer an experience and value proposition that customers appreciate. Our fourth quarter results are the latest example of how our teams continue to consistently deliver for our customers. We finished 2022 with strong momentum in growing customer relationships. As you can see from our profitability trends, we're growing them in the right way. So let me highlight some of our progress. Let's start with wireless. We delivered 656,000 postpaid phone net adds in the fourth quarter and nearly 2.9 million postpaid phone net adds for the full year. And over the past 2.5 years, we've increased our postpaid phone base by nearly 7 million to 69.6 million subscribers which represents our best 10-quarter stretch of wireless growth in more than a decade. During the same 10 quarter time span, we've grown wireless service revenues, EBITDA and also increased our postpaid phone ARPU by nearly $1. And while others may have jumped the gun to claim that they were the only ones to reduce churn in the fourth quarter on a year-over-year basis, we also lowered our fourth quarter postpaid and postpaid phone churn without offering richer promotions or free line giveaways. We consider this yet another data point highlighting that our comprehensive approach to improving the entire customer experience is working from our simplified go-to-market strategy, to our better network experience, to our focused market segmentation practices. On top of that, our growth was not only robust but profitable with 2022 being the most profitable year ever for our Mobility business. We expect profit growth to continue in 2023 as we benefit from the investments we've made in our business over the last 2.5 years. Our network teams have also consistently outpaced our mid-band 5G spectrum rollout objective. In fact, we now reach 150 million mid-band 5G POPs, more than double our initial 2022 year-end target. Our goal remains to deploy our spectrum efficiently and in a manner that supports traffic growth. In the markets where we have broadly deployed mid-band 5G, 25% of our traffic in these areas already takes advantage of our mid-band spectrum. Now let's move to fiber, where we build fiber, we continue to win. We had more than 1.2 million AT&T Fiber net adds last year. The fifth straight year we've totaled more than 1 million AT&T Fiber net adds. And after 2.9 million AT&T Fiber net adds over the last 2.5 years, we've now reached an inflection point where our fiber subscribers outnumber are non-fiber DSL subscribers. The financial benefits of our fiber focus are also becoming increasingly apparent as full year fiber revenue growth of nearly 29% has led to sustainable revenue and profit growth in our Consumer Wireline business. As we scale our fiber footprint, we also expect to drive margin expansion. In summary, we're enhancing and expanding our networks while extending our long runway for sustainable growth. And I'm very happy with the high quality and consistent customer adds we achieved last year. We've emphasized that our plan was to grow customer relationships in a thoughtful and responsible way grounded by an enhanced value proposition that resonated with customers. That's exactly what our teams have done quarter after quarter. In addition to growing customer relationships, we've executed some of the most challenging actions associated with repositioning our operations. We've doubled down on our cost transformation. We've now achieved more than $5 billion of our $6 billion plus cost savings run rate target. In 2023, you can expect the benefits from these efforts to increasingly fall to the bottom line. In fact, you've already seen the benefits of this cost transformation beginning to translate into operating leverage despite inflationary pressures. Our teams did an excellent job implementing pricing actions and business efficiencies to offset continued inflationary impacts, impacts we anticipate will be with us in the near to midterm. Part of tapping into these efficiencies entails improving acquisition costs and further streamlining our operations and distribution. Another part entails rationalizing our wireline copper infrastructure and reinvesting those savings into fiber and wireless where we're seeing improving returns. As we look at our last priority, we also continue to generate meaningful levels of free cash flow even with record levels of investment. This gives us confidence in our ability to continue delivering an attractive dividend today and in the future, while also improving the credit quality of that dividend as we expect to increase our cash generation over time. We strengthened our balance sheet last year, reducing our net debt by about $24 billion. So as we close 2022, I'm proud of what the AT&T team accomplished despite a competitive market and challenging macro environment. Turning to 2023, what's our strategy? Well, it's simple. Do it again. What exactly does that mean? It means we're focused on the same three operational and business priorities we set in place 2.5 years ago. As I've mentioned time and again, our North Star remains solely focused on becoming the best connectivity provider with 5G and fiber. We're confident we can achieve this because in wireless, we'll maintain our focus on building durable and sustainable customer growth in a rational, return-focused manner. Just as we've done over the past 10 quarters, we'll continue to take a disciplined approach to selectively target underpenetrated areas of the consumer and business marketplace and improve the perception and execution of our value proposition. We also expect to continue our 5G expansion, reaching more than 200 million people with mid-band 5G by the end of 2023. In wired broadband, we have the nation's largest and fastest-growing fiber Internet, and we expect continued healthy subscriber growth as we grow our fiber footprint. As we keep expanding our subscriber base will drive efficiencies in everything we do. This includes consistently elevating our customer experience through the improved durability and reliability of our 5G and fiber networks. When we couple our evolving networks with further enhancements to our distribution and digital and self-service channels will make a competitive customer experience even more appealing. We expect to realize additional benefits from our consistent go-to-market strategy and lower cost structures. We also benefit from our improved brand perception, strong fiber and wireless asset base, broad distribution and converged product offers. Additionally, we have a clear line of sight to achieving our $6 billion plus cost savings run rate target by the end of this year. We expect even more of these savings to fall to the bottom line as the year progresses. With that improved performance, we remain focused on further strengthening the balance sheet by using cash after dividends to reduce debt as we progress toward our target of a 2.5x range for net debt to adjusted EBITDA. Our commitment to providing an attractive annual dividend also remains firm. As our CapEx is expected to moderate exiting this year, following the peak investment levels of 2022 and 2023, we expect the credit quality of our dividend to improve on the back of our higher free cash flow and improved financial flexibility. In summary, we feel confident that our growth and profit trends are sustainable despite the uncertain macroeconomic backdrop. As I stated previously, we continue to expect that we will be operating in a challenging macroeconomic environment where wireless industry growth is likely to return to more normalized levels. The resiliency of the services we provide are time-tested and only growing in importance. When you couple this resiliency with the investments we've made to our networks and proven go-to-market strategy, we're confident in our ability to navigate potential economic headwinds that may emerge and our improving financial flexibility only further strengthens that confidence. Now I'd like to take a moment to touch upon our fiber strategy by quickly level setting on how I'm thinking about the success we've had, our plans for the next few years and how we'll hold ourselves accountable. Similar to the early days of wireless, we consider fiber a multiyear opportunity that will transform the way consumers' and businesses' growing connectivity needs are met in the ensuing decade and beyond. For AT&T, we segment this opportunity into three distinct buckets based on the specific input parameters and return dynamics each one possesses. The first is our in-footprint build where we can take advantage of our existing infrastructure, deep insights on both the customer base and competitive landscape and our market presence in order to take share and deliver attractive returns. We believe our performance over the last few years supports the wisdom of allocating our capital to these opportunities with sustainable and solid return characteristics. As we stated previously, we currently size this opportunity is passing 30 million-plus consumer and business locations within our existing wireline footprint by the end of 2025. We finished last year with approximately 24 million fiber locations passed, including businesses, of which more than 22 million locations are sellable, which we define as our ability to serve. Our build to these locations is providing great returns, as you can see from our growing fiber revenues and ARPUs. As a general rule, about 5% of consumer locations passed may not be immediately sellable, primarily due to timing factors such as building access, construction or vacancies. Over time, we expect more of this inventory to become addressable for sale. We remain on track to reach our target of 30 million plus passed locations by the end of 2025. The simple math would suggest 2 million to 2.5 million consumer and business locations passed annually moving forward. As we previously shared, build targets will vary quarter-to-quarter in any given year based on how the market is evolving. The second bucket is availing ourselves of partnership opportunities to not only expand but also accelerate our coverage in excess of that 30 million-plus location target. This is where our recent Gigapower joint venture announcement with a BlackRock infrastructure fund resides. While this deal is not yet closed, we're very excited about the expected benefit. Through this endeavor, Gigapower plans to use a best-in-class operating team to deploy fiber to an initial 1.5 million locations, and I would expect that number to grow over time. This innovative risk-sharing collaboration will allow us to prove out the viability of a different investment thesis that expanding our fiber reach not only benefits our fiber business, but also our mobile penetration rates. But what makes me most enthusiastic about this endeavor is that we believe Gigapower provides us long-term financial flexibility and strategic optionality and what we believe is the definitive access technology for decades to come, all while sustaining near-term financial and shareholder commitments. If I were to draw parallel to this partnership approach, I'm reminded the early days of wireless where the race to grow footprint was somewhat time-bound and facilitated by a similar approach ultimately culminating in today's national networks. The last bucket is framed by opportunities to connect people who previously did not have access to best-in-class technologies through broadband stimulus and BEAD funding. As I shared before, we truly believe that connectivity is a bridge to possibility in helping close the digital divide by focusing on access to affordable high-speed Internet is a top priority of AT&T. The intent of these government programs is to provide the necessary funding and support to allow both AT&T and the broader service provider community that means to invest alongside the government at the levels needed to achieve the end state of a better connected America. As the year progresses, we expect to gain more clarity around additional opportunities that exist, none of which are included in the 30 million plus fiber location target I mentioned. As we compete for the subsidy, we'll bring our operational and market experience to compete for contracts in a disciplined manner. In doing so, we may be the only participant that has the ability to bid as part of an embedded wireline operation, a scaled national wireless provider and Gigapower may participate as a focused and flexible commercial open access wireline fiber network. We think this will prove to be a winning combination in pursuit of attractive growth. The bottom line is this. Our commitment to fiber is at the core of our strategy. In footprint, we're on track to deliver our 30 million plus location commitment and we're building the strategic and financial capabilities to take advantage of further opportunities as they emerge. To wrap up, regardless of what transpires in the macroeconomy in the year ahead, we remain confident in the resiliency of the services our customers depend on in their daily lives. I believe our plan for the year rings true to who we are at our core. For almost 150 years, AT&T has invested heavily into connecting our country. And in the process of doing so, we provided a spark for innovation that connects people to greater possibility. This year, we'll continue to honor this heritage by significantly investing in best-in-class technology to build on a foundation for the future of our country's evolving connectivity needs, needs that we expect to grow significantly in the coming years. Thank you, John, and good morning, everyone. Since John already discussed the great momentum we have this past year in growing our customer base in 5G and fiber, I'd like to start by taking a look at our fourth quarter financial summary on Slide 8. First, as a reminder, with the close of the WarnerMedia transaction in April, historical financial results have been recast to present WarnerMedia and certain other divested businesses as discontinued operations. Therefore, where applicable, I will highlight our financial results on a comparative like-for-like basis. For the fourth quarter, revenues were up nearly 1%. On a comparative basis, revenues for the full year were up around 2%, largely driven by wireless service revenue and, to a lesser extent, broadband and Mexico. This was partly offset by a decline in Business Wireline. Adjusted EBITDA was up about 8% for the quarter. For the full year, adjusted EBITDA was up around 3.5% on a comparative basis as growth in Mobility, Consumer Wireline and Mexico were partly offset by a decline in Business Wireline. Adjusted EPS from continuing operations was $0.61, up about 9% for the quarter primarily due to strong organic growth in Mobility and lower interest and benefit-related expenses. For the full year, adjusted EPS from continuing operations was $2.57 and I should note that we've taken a $24.8 billion noncash goodwill impairment charge in conjunction with our annual goodwill assessment, primarily due to increases in discount rates associated with the overall rise in interest rates. We also took a noncash charge of $1.4 billion to abandon certain conduit assets related to the ongoing rationalization of our copper network. Free cash flow for the quarter was $6.1 billion, including about $800 million in DIRECTV distributions. This is an improvement of $780 million year-over-year, even with a $1 billion lower distribution from DIRECTV and $500 million less in FirstNet capital reimbursements. We also delivered on our revised full year guidance with free cash flow of $14.1 billion for the year. Cash from operating activities for our continuing operations came in at $10.3 billion for the quarter, up $2.3 billion year-over-year. For the quarter, capital expenditures were $4.2 billion with capital investments of $4.7 billion. Full year capital investment marked an all-time high at $24.3 billion as we continue to make record investments in 5G and fiber. Now let's look at our Mobility segment operating results on Slide 9. For the fifth consecutive year, our Mobility business grew both revenues and EBITDA. Revenues were up 1.7% for the quarter and 4.5% for the year. Service revenues were up more than 5% for both the quarter and the year, driven by continued subscriber growth. This exceeds the raised annual guidance we provided to you last quarter. Mobility EBITDA was up about $740 million or more than 10% for the quarter, driven by growth in service revenues, transformation savings and the absence of 3G network shutdown costs versus the fourth quarter of 2021. This was partially offset by higher bad debt levels. For the full year, Mobility EBITDA grew nearly 4%. Even as competitors introduce richer promotional offers during the holiday seasons, our consistent go-to-market approach once again drove our results. This gives us confidence that we have the right formula and structure in place to continue to grow customers, service revenues and EBITDA at a healthy clip this year. Mobility postpaid phone ARPU was $55.43, up $1.37 or 2.5% year-over-year. ARPU growth continues to come in ahead of our expectation and largely reflects our targeted pricing actions customers trading up to higher price unlimited plans and improved roaming trends. As John previously mentioned, postpaid phone churn of 0.84% for the quarter declined year-over-year even as we were less promotional compared to our peers. We believe that this decline is reflective of our improved customer value proposition. In prepaid, our phone churn was less than 3% driven by Cricket phone churn that was substantially lower than 3%. While we believe industry wireless subscriber volumes will continue to pace towards normalized levels this year, we also expect our consistent go-to-market strategy to help us deliver strong relative performance and ongoing customer growth. Now let's move to Consumer and Business Wireline results, which are on Slide 10. Let's start with Consumer Wireline. As John mentioned, our fiber customer growth and network expansion continue. And wherever we have fiber, we win share. We added 280,000 fiber customers even in a seasonally slow fourth quarter that was impacted by lower year-over-year household move activities and challenging December weather conditions. The increasing mix shift from legacy products to fiber drove strong broadband results, and we expect these trends to continue. Broadband revenues grew more than 7% year-over-year due to fiber subscriber growth and higher ARPU from the mix shift to fiber. Fiber ARPU was $64.82, up $2.20 sequentially with intake ARPU now approaching $70. Consumer Wireline EBITDA grew over 20% for the quarter and nearly 10% for the full year due to growth in fiber revenues and transformation savings. Turning to Business Wirelines. EBITDA was relatively flat for the quarter due to $90 million in intellectual property transaction revenues and ongoing transformation savings as we continue to rationalize our portfolio of low-margin products. In fact, margins were up 110 basis points year-over-year, thanks to our transformation process. This rationalization process will continue in 2023 as we remain focused on the opportunities that our 5G and fiber expansion create in the small and midsized business category. Our Business Solution wireless services revenue grew more than 7%. This is very impressive given the fact that we already have the second largest share in are growing faster than our peers. Now let's move to Slide 11 for our 2023 financial guidance. Let me walk you through how we're thinking about operating expectations for 2023. First, we expect to continue to grow Mobility subscribers against a return to a more normalized industry growth. We also expect continued benefits from a larger subscriber base and improving ARPUs. This should result in wireless service revenue growth of 4% plus for the full year. For broadband, we expect revenue increases of 5% plus reflecting a higher mix shift to fiber with improving ARPUs partially offset by continued legacy revenue declines. Overall, we expect to grow total revenues next year. However, as you all know, variability in equipment revenues driven by industry volumes could be a factor on consolidated top line trends as we think about EBITDA trends in 2023. We expect to grow Mobility EBITDA mid-single digits as our disciplined approach helps us grow our valuable subscriber base. In Business Wireline, we expect EBITDA to be down high single digits due to continued declines in legacy products, partially offset by incremental cost savings and increased fiber-based revenues. As you consider the first quarter for Business Wireline, it's worth noting that 2022 included a onetime incentive compensation benefit that will impact year-over-year comparisons. In Consumer Wireline, we expect to grow EBITDA in the mid-single-digit range, plus or minus, due to continued growth in fiber revenues and transformation savings, partially offset by continued declines in legacy copper subscribers. We expect to benefit from ongoing corporate cost reductions. Altogether, this yields consolidated adjusted EBITDA growth of 3% plus for the full year. When you think about adjusted EPS calculations, note that our guidance reflects nearly $0.20 on per share of headwinds associated with noncash pension costs related to higher interest rates and to a lesser extent, lower spectrum interest capitalization. We also expect to incur more than $0.05 of noncash headwinds related to a higher effective tax rate of around 23% to 24%. Combined, these headwinds aggregate to about $0.25 year-over-year. Normalizing for these noncash items, our guidance would imply adjusted growth consistent with our expected growth in adjusted EBITDA. Given these assumptions, adjusted EPS is expected to be in the $2.35 to $2.45 range. We also expect adjusted equity income from DIRECTV to be about $3 billion for the year versus $3.4 billion in 2022. Here's what to consider when looking at our free cash flows for 2023. First, we expect adjusted EBITDA growth of 3% plus. Next, expect cash interest to be down about $500 million. Assume your cash taxes will be higher in 2023 versus 2022 to the tune of about $1 billion. And expected cash distributions from DIRECTV should be down about $1 billion. We continue to expect that 2022 and 2023 will be our peak investment year. So capital investment is expected to be consistent with 2022 levels. We also expect about of $2 billion of working capital improvements, largely from lower deferrals and higher noncash amortization of deferred acquisition costs. As we mentioned earlier, we expect a more normalized industry growth volume which is expected to help working capital as well. When you combine all these factors, you get to a free cash flow expectation of $16 billion or better. This is about twice as much as our current annualized dividend and more than enough to cover other commitments. Similar to last year, we expect greater free cash flow generation in the back half of the year based on higher capital investment levels and device payments in the first half of the year as well as the timing of the annual incentive compensation payout. We will use our free cash flows to pay out our dividend and to pay down debt as we continue to progress towards our target of 2.5x net debt to adjusted EBITDA, which we anticipate will take place in early 2025. And lastly, the guidance we provided to you is based on our current reporting. We expect our segment reporting in 2023 will remain the same as last year. However, I'd like to note that we no longer plan to record prior service credit benefits to the individual business segments with a corporate elimination. Instead, it will only be recorded in other income. Overall, we are confident in our plan for the year. And as John mentioned, it takes into account our expectations for a more normalized industry growth backdrop against continued challenges in the macro environment. Our confidence is underscored by the resiliency of the services we offer, the consistent strength of our go-to-market strategy, our ongoing momentum in core connectivity and most importantly, our team's unwavering commitment to deliver best-in-class services to consumers and businesses alike. I think I'll start off with a follow-up here on the outlook that you provided. I appreciate some of the color that Pascal provided about the different operating segments. Maybe at a higher level, could you give us a sense as to what you mean by a more difficult operating environment? In other words, to what extent does the outlook for this year anticipate maybe a recession or ongoing inflationary pressures? And then I imagine one of the questions we’ll be getting today are, what are some of the key swing factors? And so if we were to use your adjusted EBITDA guidance as an example, what's the scenario that gets you to 3% growth and what could be the swing factors that might take that into the or higher category? Hi, Brett. Let me go ahead, and I'll start and then Pascal can jump in. So first of all, look at the foundation of what we're telling you is we've been I think, very conservative and thoughtful in the guidance we pulled together. It is a tough environment to predict. There's a lot of geopolitical things going on that I think anybody would have a hard time seeing and do a crystal ball on, and that's probably the most difficult wildcard that I think we've tried to take a conservative stance of what we see in the economy today and what the foundation that's rested on is. We know that the services that we provide to customers are pretty resilient even during more challenged economic times. And so we have a reasonably high confidence level that our customers are going to continue to want to use the product and pay us for it. I think if you go back and look at my public comments probably over a year ago, I've had a relatively conservative view of where I thought the economy was going to go. I've been fairly vocal that I think inflation is a tough thing to have a healthy economic environment and that's good for everybody and it creates some challenges in places. And ultimately, a lot of that came to pass. The good news is I think we're through the worst of it, and we see it easy. But as you heard from my comments, we've expected that we're going to continue dealing with some of that pressure as we move through this year. So we don't have an outlook that says that we've solved the problem. We have an outlook that says we're going to continue to deal with pressures that are hitting some of our line items economically that we've got to account for and things like energy and some of the continued wage and employment pressures that we've had to deal with that will carry through and we have some longer-term contracts that didn't come up during the last year that we know are going to hit us this year in renewals that we have to factor into that. And I think we've tried to do the best we can around it. I see the economy being relatively stable right now. We're not seeing anything that's causing us to be extremely concerned about it. But what happens later in the year, who knows. The point we've made is we've kind of assumed that we're not going to be in a robust growth environment as we make our way through the year. And I would tell you if you're asking kind of what the swing factors are, I think the swing factor, frankly, is if there's some kind of a geopolitical disruption that's something significant that none of us anticipated or that we hope would never happen, it creates a disruptive event. That's probably the thing I'd look at and say, I couldn't predict it. I couldn't plan for it, and that's going to be the issue that we have to deal with, that just pops up and isn't going to be just an AT&T issue. Yes. Brett, the only other thing I would add is, look, we've assumed in our outlook a more normalized industry growth environment. So to the extent it's more than that or less than that, that could be a swing factor. But the thing that I think is important, and I said this in my comments there is, whatever the environment is, we expect to perform relatively well versus the peer set. Maybe just a couple of quick follow-ups on capital uses. Pascal, you may have said this in your remarks, but what's driving the $2 billion in working capital savings this year? And what are your confidence behind that? And then could you remind us on the working -- on the CapEx side, obviously, $24 billion again this year. But just what was the longer term sort of view? When can we expect that to start to come down? And what do you guys think of as a more normalized sort of CapEx, especially given what you have now with Gigapower and all the fiber initiatives? Sure thing, John. Here is the way I think about the $2 billion that I flagged in our guidance for 2023. The last several years, we've been growing our subscribers in wireless with that came some upfront acquisition costs. We've said for a while we expect that to level out in 2023. And so once you have that leveling out, we are no longer going to be spending more each and every year than the prior year in acquisitions. So that leveling out, there is assets that are on the books associated with the deferred acquisition costs of those subscribers. That's going to be amortized we have great visibility into that amortization, and that's obviously noncash because we spent the cash in the prior year. So that we have very good visibility to. And look, if we grow more than last year in terms of wireless subscribers, that could be a swing factor, but I don't anticipate that. CapEx, the thing to keep in mind is we plan to be at peak levels in '22 and '23 because of the significant contributions that we are getting from DIRECTV in '22 and '23's CapEx is fairly meaningful amounts for spectrum deployment and transformation that will begin to moderate as we exit this year. We haven't updated the guide we provided at Investor Day, but clearly, we expect to trend down towards more normalized capital intensity as we exit this year. Turning to fiber. Gigapower was a great announcement, but a little smaller than we had expected. John, how do you think about the 1.5 million versus the potential of that venture or for others in that model? And your own on-balance sheet fiber construction of -- I think you said $2 million to $2.5 million annually. It seems like a slower pace than we had been discussing. Is there anything changing there? And then finally, just to John's question, one quick clarification on the free cash flow. Pascal, is that working capital going to contribute $2 billion to free cash flow in '23? Or is it just offsetting what had been a $2 billion drag, I think, in '22? Phil. So first of all, as I mentioned in my comments, I view the fiber portfolio as that, a portfolio. It's a portfolio of options for us to look at where the return characteristics are most optimal on how we deploy capital around that. And I'm trying to be pretty overt in my commentary to all of you that we understand that we need to be very disciplined in demonstrating to all of you that each of those portfolio decisions and how we put capital against that is, in fact, driving acceptable returns. I'm very mindful of the fact that the Gigapower announcement is a model that the investor base is unfamiliar with. This is something different and something new. And I want to be very sensitive to the fact, just like we did when we were deploying in-region fiber and stepping up our investments. I've tried to be transparent with all of you around what our progress has been on the key drivers of the economic return of that investment. We've been sharing pretty aggressively things with you like ARPUs and penetration rates and a variety of other things that give you the confidence that in fact, that that's a sustainable, smart long-term investment. This new Gigapower model is a bit different. And I think it would be normal for any of you to look at it and say, gee, it's going to return at the same level. And so to demonstrate to you that I'm serious about ensuring that every incremental investment decision we make in this look, 1.5 million homes, you may say, well, that's not a lot. It's over $1 billion of investment to be able to go do this. We set up this first tranche to be able to come back to you over the course of 18 months and give you information that raises your confidence and in fact, we are driving the returns on this in the way that we anticipate them to be attractive and the management team that has been put in place and how the partnership is set up is intended to do exactly that. We will be in the market very, very soon right after the announcement. I intend to have 12 months of penetration information that I can bring back to you. And you can bet that when we're successful doing this and we demonstrate to you that we have the numbers to back it up that it won't necessarily still be 1.5 million. I would also tell you, I want to be thoughtful about, as I've made the comment what is it that we should own and operate 100% to ourselves and what we want to do within the partnership, just like we might have done when we were building wireless infrastructure a couple of decades ago. And if we hit the ball out of the park and things are great, we may choose to do some of this in-house and on our own and not necessarily subjected to a partnership. On the other hand, if we need more scale and we need to move faster, we have a vehicle now that's set up that we can move very quickly to increase the amount of funding and the amount of capacity that's in that entity to take advantage of that. And so we're going to have data that we can come back to you with, and we'll, I think, do the right thing and try to make sure that you're moving along with us every step of the way. And I just see this as another tool that gives me a lot of flexibility and a lot of options. Relative to the in-region fiber side of things, as I said, I'm looking for a portfolio of returns. And what I tried to stress in my opening remarks is, I'm giving you a characterization right now of what we think are high-return options within the 30 million passings that we committed to and what that looks like, and I've tried to clarify because I know some of you have been trying to do the math on it. But we have these other options now. I want to balance out what I think the return characteristics will be through the Gigapower initiative and we are going to now see some volume and capacity coming in out of region -- or excuse me, out of the 30 million build that will be subject to BEAD funding. And some of that subsidy may have a very different return characteristics than some of the stuff we're doing organically in region right now. And I want to have options open to understand that and look at that aspect of the portfolio as well. And I think we'll get clarity on that is on the end of the third quarter of this year that we start to see where we're successful in bidding for that money, how much it is, what kind of a build line do we put on the business in terms of having to add capacity to get the bill accomplished and how does it fit into the kind of operating territories that we think set us up for a geography and a footprint that's intelligent for us to operate moving forward. So that's kind of how I think about it in aggregate, and I'll let Pascal pick up your question on the free cash flow clarification. Hey, Phil, the simple way I think about the majority of the $2 billion is this. We have deferred acquisition cost that's on the books where the cash went out in prior years. That amortization -- it's going to continue to be amortized against EBITDA in 2023. That is noncash expenses burdening. So when you -- just the sheer mechanics of adding that back to our free -- to our EBITDA will elevate the cash EBITDA that the business produces. John, if I can follow up on one. Start to be a split. Do you look at Gigapower and BEAD spending as alternative places to spend your capital and effectively now slowing the organic pace to get to that 30 million? I've given you the pace of how we get to the 30 million. And so I don't see that changing. I think we're committed to what I just articulated to you. So if you're asking am I going to see -- am I going to come back and give you an incremental revision of that 30 million to substitute? No. Great. If I could just stay on the broadband theme, if I could. Perhaps I think you talked perhaps about providing extra color on the financial construct of the BlackRock JV? Are you contributing any capital? Any assets how exactly should we expect that to flow through the financials? And John, on the beat, perhaps you just give us a reflection on the status of the process, the timing, how this is going to play out. I think there's been a lot of concerns about delays, the mapping process, the challenges and also some of the state broadband offices maybe not being ready to stand this up. So how do you see this evolving? And when do you think you can actually get shovels in the ground to get know what funding been awarded? And then just finally, getting to 30 million locations is great. What about the prebuilding with fiber with fixed wireless in some of those locations. I think you've talked about that. And how does fixed wireless play into some of that other 30 million plus locations that won't be getting fiber in the near term? Sure. So Simon, I'll be -- I've got to be careful about how much the partnership. It's a partnership structure, it's an entirely separate partnership structure, so you shouldn't expect to see any of the financials pull-through on a balance sheet structure for us, you should expect it to come in is investment income. We'll give you characterizations of the success of that and as it carries forward and you should think about this as both partners carrying equal weight in the execution of the entity. I think that probably gives you a good enough sense of how it carries through. And if you have something else you want to push on, I can try to give you a little more color. The BEAD timing, my point of view is I think there is -- there's been enough information put out there right now. We're going to go through a clarification cycle on the first set of data. I think that's moving along at a reasonably good cliff right now. And I think, frankly, the bigger states, those that have a more robust staffing capability are being pretty prompt and aggressive in working through getting that data set squared away. I would agree with you that there's going to be some states that are maybe a little bit slower than others, but my gut is when you're thinking about kind of the 80-20 rule, the bigger states, they're going to have the bulk of the funding are pretty zoned in on this, and they're moving pretty aggressively to get the process underway. And while there may be some smaller states that take a little bit longer to get their act together or are waiting to see how models develop in some of the more lead states that have bigger staffs to consider these things and then kind of be fast followers. I don't think that's going to inhibit some of the more aggressive states and being in the process and us being in a situation where in the third quarter, there's going to be monies starting to flow down from the Federal government and being turned back to the states for execution. So I don't think you're going to see any substantial shovels on the ground and certainly, customers being served in any substantial way this year. But I do think you're going to see projects and monies awarded before we exit this year, and you will see those volumes start to come online as we move into periods of 2024, and I expect that those will be concentrated in some of the bigger states that have more robust staff that can move through this fairly quickly. And pretty much have a view of how they want to go about doing this. They're just trying to get the data to fit into the process. As I've said before, we view fixed wireless as being a tool in the toolbox that we can use to deal with opportunities in areas that are less densely populated. We'll have our next rendition of the product in the market this year. There will be places where we view it as being an acceptable substitute for fiber deployment. They tend to be -- they are going to be less densely populated areas where it makes sense to do that. We have a plan as to how we want to test our assumptions around that. We will deploy and take advantage of that. I think it can have an opportunity to help us on some of the long-standing hybrid fiber copper base that we have that maybe has some speed challenges, and it will probably help us manage some of the churn characteristics associated with that, and I would expect to use it in that case. And then I would also add, look, there's a lot of businesses that maybe aren't in those less densely populated areas where this will be a perfectly acceptable and strong product, given the nature of how their business runs and what they need for their daily data needs and service needs. And so I do expect that we're going to have an opportunity to complement some of our strength in wireless distribution into the business market to provide a more robust fixed broadband alternative, fixed wireless broadband alternative to those customers, and bundle and package it in where it makes sense. Simon, one other point on the capital structure for the JV to consider is that we do expect it to carry a meaningful amount of debt funding as well. We have contributed some into the partnership. The reason you're going to see it get off the ground as quickly as it will and bring its first customers on in relatively short orders because while we have been structuring and negotiating this, we've been doing a fair amount of work in parallel quietly. And so the partnership, as we've indicated, is already structured with the management team that's in place that has been doing a lot of work on the offer that knows the markets we're going to be in that has infrastructure and system setup that they can be ready to go on. And I think this is probably one of the things our partner found attractive about this. It's a first-class management team with a lot of capabilities behind it, and we will take some credit for the contribution of that work that we've done within the scope of this year. I guess first, I just wanted to go back to the notion of wireless postpaid phone market "normalizing." I think a lot of people look at the relatively high correlation between the substantial step-up that we've had in the industry to roughly 9 million postpaid phone nets a year for the last couple of years and AT&T's kind of resuscitated growth, as John pointed out, over the last 10 quarters. And as such, when people consider the industry "normalizing," there's a pension out there, I think, to disproportionately assume that whatever amount of tide comes out on industry growth will be disproportionately allocated to AT&T because it disproportionately benefited over the last couple of years. I was wondering if you could kind of talk about that and whether you think that's realistic and that informs some of your working capital benefits that inform the cash flow or whether you think that, that's wrong and that you can kind of -- if there is a tide that goes out, it's more pro rata across the industry? That's number one. And then number two, John, you touched on something in the prepared remarks that we haven't talked about a lot here in the U.S., largely because we haven't been moving in this direction until you guys really started this fiber initiative, which is copper decommissioning. And for instance, in markets like Canada, it's a huge topic where they've widely overbuilt their copper plant and we're talking about timing and magnitude of the benefits that you start to get there. Could you kind of elaborate a little bit? Is it a little too early to start really talking about this as a tailwind in something like '24 or is it really with us? Sure, Dave. How are you? I don't agree with your thesis at its point. I absolutely 100% dismiss your thesis. And I don't think that's how the market is structured and functioning today by any stretch of the imagination. I think our -- I go back and I look at our performance over the last 2.5 years, first of all, I would tell you, I think the industry is a lot more healthy than many who would like to trying to come up with this narrative? Is competition up? Or is it destroying itself? I mean I see a pretty consistently competitive industry over this period of time. And I tend to look at it not just on customer counts, but I look at things like both wholesale and retail revenues and how that's flowing through to service revenues. And I see a relatively balanced dynamic in the industry, but the math would tell you that balance dynamic would suggest we've been picking up a bit of share when it's all said and done. And I don't think that's a benefit of the number moving from whatever you assume the normal stasis is $7.5 million to $9 million. In fact, I would say of customers that are paying a reasonable monthly bill, we've taken more than our fair share, and I'm more interested in taking revenue share and profitability share than I am necessarily just taking a subscriber share. And I think our numbers would suggest that we've seen an ever improving trend over the 2.5 years in our ability to do that. So I don't submit to your point of view that if the "industry normalizes" we revert back to kind of where we were three years ago. I think where we are is because of how we're performing today, not what was going on three years ago, and that's kind of how I think about it. What I would tell you, Dave, is I don't think there's a windfall that comes in on restructuring of legacy costs. And I've I think I've been on this theme for a little while. I mean we've been working this issue pretty aggressively since the day I came into the job, and I would say we had to start formulating the plans when I came in, but now we have a very robust and functioning organization that we're doing this kind of day in and day out. And I spend more time talking about investing in the new business and the growth that we can get on sustainable fiber and a 5G infrastructure than I do on talking about what we are taking out of service, but we are taking stuff out of service. And so when we start managing things like our energy costs down, it's because we're decommissioning equipment and taking it off the copper grid when we are able to manage our dispatches down and show you improvements in our operating dynamics on dispatches. It's because we have a smaller footprint to manage. We are doing this day in and day out. And our pace at which we're doing it is accelerating. We've -- I've given you some hints along the way about the number of products that we've shuttered and when we shuttered those products, it starts to take operating costs out of the business. This is part of what we have in our forecast to you to continue to improve our operating costs. So you're seeing this operating leverage start to come into the business, and it's partly contributed to the fact that we're managing through these legacy costs. And as we give you the forecast for cash this year, when we talk about improvements in our overall cost structure, some of it is coming on the backs of what we're doing here. And I'm very well aware of where our cost structure is on a comparative basis to others that we compete with in the industry, some of which do not have the hybrid asset structure that we have of both fixed and mobile. And we are on this mission to ensure that we're not operating any of that at a disadvantage over the next three, four and five years. And I think you're going to just see this ratably come in over that period of time as we work through what is -- it's frankly a bit of a painstaking process to go through. It's central office by central office line by line, customer by customer, but it needs to be done. I think it can be done in a way that makes us a better and healthier business where we have a great hybrid of a fabulous fiber footprint with a fabulous wireless network that is ultimately the future of how customers are going to buy together, and I like that. I think that hard work will be rewarded in that regard, but I will fully admit, we are creating new intellectual property here around how you get to this space. And I'm choosing to do it organically internally, not through a front-end private equity transaction that puts a little bit of cash in my pocket but ultimately has the value of it accrue to somebody else over the hard work of three, four and five years. I want to stay, if I could, with this topic of your portfolio of broadband, John, if I think about your kind of overall Mobility national footprint, it sort of maps with today roughly call it, 16%, 17% of the country already overbuilt with fiber, another 10% or 12% to be overbuilt with fiber. Can you just talk about how you think about the consumer value proposition in those different segments where you have wireless that doesn't have a fiber component where it does? And then -- and what role fixed wireless might play to sort of round out that consumer value proposition. Yes. The way I think about it, Craig, is -- and I tried to use this reference earlier is, I think it's a bit of a -- I don't want to use the term land rush, because it's not it's not that easy to put fiber and it takes a little bit longer than a land rush, but we are definitely in a window right now where I do believe a good portion of the United States will ultimately have a fiber connection to it. And I believe there will be -- if you think about this over the long haul that we're moving to an industry, and I've been pretty clear about this, ultimately, customers are going to want to buy connectivity from one place. They don't necessarily love making a distinction between their fixed provider and their mobile provider. And I think over time, we're going to see an ordering of industry assets that leans more toward that. And my point of view to be in a strong position as you -- if you have the best technology out there and you ultimately build the largest footprint fastest, you're going to be in a better position to ultimately play in the outcome of how that restructuring gets done, and you're going to have the strongest customer base on a relative basis and owning and operating those assets and having the ability to control the product offering and control the cost on it will be the best way to control your progress going forward. So yes, it's a deliberate process to continue to build fiber infrastructure and ultimately overlay it with the wireless business, but that's a process that I think is incredibly durable and sustainable. And my job is to make sure I'm doing it faster and better than anybody else and I think it'll come out in an okay place as a result of that. And as I said, my job is to ensure that people who give us money to go and allow for us to make that investment feel that on a marginal basis, on an incremental basis, we're doing that in a way that's driving successful returns. I think fixed wireless, as I said, has its place in the portfolio. I don't see it's place long term in dense metropolitan areas, and I don't see it in reasonably well populated suburban areas. I don't see the dynamic of that product, and I've been pretty clear about this, if I start to think about consumer behavior and demand of consumption, and I start to take those curves out over three years, I don't see that as the optimal way to service a customer in the near term. So I think the mobile network's role in life is to ensure that whenever somebody is away from a fixed location, they can still get the same kind of capabilities that they get while they're at home, but there's only a certain amount of bandwidth that a mobile network will ever be able to foster and support in that regard. Mobile bits are going to be higher-value bits. They're going to need to be engineered differently. They should sell at a premium because of the supply and demand dynamics on it. And I want to ensure that my mobile network is, in fact, delivering that premium solution on those mobile bets when they need to be provided. And it's absolutely 100% there to do that. And I think at the end of the day, if your mobile network is doing that mad fashion, then you're going to have an opportunity to work in the high-value mobile space for what are going to be emerging capabilities that people need to facilitate the true promise of 5G and real-time transmission ubiquitously any place anywhere. Just thinking a little bit more about the wireless growth opportunity, can you share with us how AT&T is doing with the uptiering of customers onto unlimited and premium unlimited plans? And then given some of the comments on inflation, are there opportunities for AT&T to update wireless and fiber pricing again this year? And are any of those opportunities included in the guidance? Hi, Mike. So I'm not going to -- look, it's just not good hygiene to talk about what our plans are on pricing, and I don't intend to do that today. I would just maybe point you back to -- we have a management team who is very good at understanding where we have great value to our customer and where we're selling in that market. And are we getting the maximum value and value exchange back from the customer. And that's across all of our products and services. Last year, I mean, you can see we saw an area where we felt like -- we had some customers that weren't taking advantage of the best plans that we had to offer with the most recent features. and we decided to work in our customer base to help them understand that there were better places they could go where there was maybe an exchange for them to pay us a little bit more, but to get a lot more for what they were paying us. I think we executed that incredibly well. We just gave you churn numbers that were incredibly strong churn numbers, all while we did that, and I think you should step back from that and say that's pretty good execution. I'm not sitting here telling you about I grew service revenues and I'm dealing with a customer flight problem. I dealt with lower churn. And I think that's a testament to the fact that we were able to get a win-win proposition and our customer base with the customers walked away feeling better about the circumstances, and we'll continue to look for those opportunities. Anywhere in our portfolio on any product where we think we can do those types of things, that's just part of being good management. I would expect that there's always opportunities for us to look into that where I think we are on our ability to walk people up the value continuum. We still have room. We're not -- we're not through the 5G replacement cycle. As you know, when a customer comes in and chooses to do that upgrade, that's a great opportunity for us to talk to them about what product and services that they have and to help them understand that maybe buying a more robust plan or fine-tuning how they're buying plants for us might fit into their portfolio and give them the best value. And we do expect we're going to continue to make headway on that. That's part of that service revenue growth the past call guided due to. I don't think anything that we've got in there is Herculean. We've been talking about this for the better part of three years with you. Every year, we've managed to do what we said we were going to do, and it's been consistent with the service revenue numbers that we forecasted for you. I think you should also understand that the global economy is not completely recovered from the pandemic. We still expect that as travel continues to normalize itself that we're going to see a little bit of uptick in relief coming from the likes of more global visitors coming in on roaming and people going places. I think Asia is still going to be suppressed for a period of time, but let's hope the back end of recent policy changes that have occurred in Asia means that we will eventually hit a normalization there that will ultimately get us back to kind of pre-pandemic norms at some point, which is it's good to be going down that path as opposed to having a major footprint that is kind of trying to create a fortress and not allow people to move back and forth between their borders. So we started at the beginning of the end there, which is good. So I don't feel any concern around whether or not we can effectively move people up that continuum. We still have room to grow. We're banking on that in our guidance and we'll execute around it just as we have any other years. I don't know if you want to add anything there, Pascal. So again, I appreciate your time this morning. I'm really pleased with the year. I thought it was a strong consistent execution year I'm just equally as pleased that we've done the right things to set us up for continued growth as we move through '23. I hope you feel the same. I know the management team is very focused on delivering what we shared with you this morning is our expectations. I feel really good about where our customer base is. As I mentioned just a few moments ago, to have churn levels in our wireless business running at the position they're in with the competitive intensity that is occurring in the industry to have the position we have with our broadband base on fiber and the customer satisfaction is coming with it, I think, bodes incredibly well even in an uncertain environment as we're moving forward. And the good news is, I think we can grow in both those places to continue to drive the kind of tempered indirect growth that we shared with you. So we're looking forward to doing it again next year. I think we've got the right opportunities in place. I think there's a lot more that we know we can still do to run this business better, and we're about doing that to ensure that we deliver improved performance for you moving forward. And ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T Conferencing Service. You may now disconnect.
EarningCall_1413
Good day and thank you for standing by. Welcome to Trip.com Group 2022 Q3 Earnings Conference Call. [Operator Instructions] Please be advised that today’s conference is being recorded. I’d now like to hand the call over to your first speaker today, Michelle Qi, Head of Investor Relations. Thank you. Please go ahead. Thank you. Good morning and welcome to Trip.com Group’s third quarter of 2022 earnings conference call. Joining me today on the call are Mr. James Liang, Executive Chairman of the Board; Ms. Jane Sun, Chief Executive Officer; and Ms. Cindy Wang, Chief Financial Officer. During this call, we will discuss our future outlook and performance which are forward-looking statements made under the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent and uncertainties. As such, our results may be materially different from the views expressed today. A number of potential risks and uncertainties are outlined in Trip.com Group’s public filings with the Securities and Exchange Commission. Trip.com Group does not undertake any obligation to update any forward-looking statements, except as required under applicable law. James, Jane and Cindy will share our strategy and business updates, operating highlights and financial performance for the third quarter of 2022 as well as some outlook for the fourth quarter of 2022. After the prepared remarks, we will have a Q&A session. Thank you, Michelle. Thank you everyone for joining us on the call today. In the third quarter, we are delighted to see strong performance in overseas markets and improvements in China domestic market, driven by robust travel summer demand and the relaxation for restrictions. Despite the impact of COVID’s resurgence since late August to which overshadowed the China domestic market, in the second half of the quarter, Trip.com Group continues to deliver better than market performance with our domestic hotel and air ticket revenues, both seeing positive year-over-year growth. In China, the adoption of more targeted and precise pandemic control measures in the third quarter has skewed a rise in air travel demand, reflecting the resilience of travel industry and Chinese customers’ strong demand for travel. Despite the resurgence COVID in the back half of the quarter, although China’s domestic hotel bookings in Q3 showed positive growth over last year and have almost fully recovered to the 2019 level. We are happy to see further optimization in the recent COVID policy adjustments. The new adjustments laid a solid foundation for the rebound of domestic travel and the recovery of cross-border travel. On the international front, our overseas market continued to ride on the growth trajectory and progress towards full recovery to the pre-pandemic level. Overall, hotel bookings in our global platforms in Q3 grew by over 45% versus 2019 and have surpassed 2019 level for three consecutive quarters. The reopening of borders and lifting of quarantine measures in Asia was bringing relief to the travel industry in the region. The current upswing presents an opportunity for us to further drive into the globalization strategy. As we remain focused on creating values and providing frictionless customer experience to our users, we will be able to gain traction to the post-pandemic travelers. We will continue to dive deep into our global markets by strengthening the cooperation with our global partners and cooperation among our brands and platforms to fortify our one-stop service model, which allow us to accommodate the users’ needs of choice, value, quality and reliability. Overall speaking, it is encouraging to see continuous growth in overseas markets even when the demand for revenge travel has already been largely relieved. As the global market continues to recover with China market heading towards further relaxation, we are now standing right at a turning point. We remain confident and positive in the long-term growth potential of travel industry and our capability and position in the market. While being cautious to the near-term concerns and uncertainties, we are fully prepared to rekindle the magic of travel. Thank you, James. Good morning, everyone. I would like to start with a quick overview of our performance in the third quarter and update on our operational highlights. First, overall performance on China market, in the third quarter of 2022, China domestic travel industry saw robust recovery following the easing of pandemic situation in June and was driven by the strong travel demand in the summer. Our China domestic hotel bookings outgrow the 2019 level by approximately 20% in July and maintained a positive growth in August. Despite pandemic resurgence since late August, our overall domestic hotel bookings still managed to recover to the 2019 level and domestic hotel revenue increased by 25% year-over-year, while the same-city staycation hotel bookings in this quarter grew around 60% versus 2019, we will also see long-haul hotel bookings rapidly picking up as a result of the easing of COVID rules. Long-haul hotel bookings increased by over 130% sequentially from the previous quarter. Such results reflected the solid demand for long-haul travel and assured our strong performance once the market further opened up. Second, on the global markets, on the other hand, the global market performance continued to improve. Across the APAC, borders are opening and the quarantine measures are being lifted as more and more Asian regions embrace a return to travel, following Japan and Taiwan who opened their doors to travel. Hong Kong also announced the ending of the formal quarantine for international travelers in September. The opening up of East Asia further accelerated the recovery pace in APAC markets after Southeast Asia got a heavy start last year and are already reaping the rewards. On flight performance, overall air ticket bookings on our global platform, has achieved over 100% year-over-year growth, while air ticket bookings in EMEA and American markets continued to show double-digit year-over-year growth. In Asia-Pacific, the growth was stellar at over 400% above the same period in 2021. We expect to see such momentum extend into the fourth quarter and hopefully can surpass the 2019 level by then. For hotel, overall hotel bookings on our global platform has increased by over 45% above 2019 level in the third quarter with domestic hotel bookings in non-China market increased by 300% versus 2019. As the growth in the global market remains robust, we continued to outperform industry in all our major markets, especially in Asia-Pacific region. In the third quarter, our hotel bookings in Indonesia, Malaysia, Hong Kong, Southeast Asia, etcetera all saw triple-digit growth over the 2019 level. These markets have been growing by triple-digits over the previous three consecutive quarters and we anticipate further growth in the Asian market. Now on business line. First of all, for accommodation, with accommodation being the center of every single trip and at the core of our one-stop shopping platform, we continue to invest in strengthening our value proposition to our customers and our hotel partners. In China domestic market, we continue to strengthen our product capability and market efficiencies to increase additional value for our partners and to tighten our relationship in order to differentiate ourselves from the other players. We maintained focus on creating a win-win situation for the parties on the value chain through our TripPLUS program, in which users can enjoy extra benefit and our partner hotels can gain access to our pool of high-quality loyalty customers and create incremental upsides. In Q3, over 50% of our TripPLUS reservations come from high-end hotels. In the lower tier cities, we continued to push forward our co-branded membership programs to expand our customer base. Our domestic brands are also tightening internal collaboration with an aim to attain high user acquisition efficiencies through price competitiveness and a cross-sell from multi-gateway products. On the international front, we continued to delve into intricacies of local markets and remain focused on increasing brand awareness and capturing local user demand as well as strengthening our ties with the local suppliers. Through expansion of coverage, we could leverage our unique and competitive product offerings to gain traction to a large group of audience. Therefore, improving our market penetration, we continue efforts to push forward with localization and the user experience upgrade initiatives, which will in turn help to drive high user engagement and stickiness which will translate into higher level of visit frequencies, spending and user retention. Following the robust recovery of global travel and tourism, our overseas activity business continued to thrive in Q3 with a record high quarterly GMV increasing by 150% year-over-year. Close collaboration with key partners also enable us to build up our competitive advantage in the market. We have been making great progress in a major market across the Asia-Pacific and Transatlantic regions and will copy our experience in the other markets. On user engagement, the areas of the global travelers have evolved over the past 3 years from their travel preference to decision-making process. In the third quarter, we continued to improve our content generation and user engagement capabilities. In September, there were 76% more content being generated by our users when compared to the same period last year. In terms of user engagement, average view duration on our content platform increased year-over-year. Average number of content viewed per user also increased by about 25%. Fourth, corporate responsibility. While seizing every chance to create value for our customers and partners, our mission to pursue the perfect trip for a better world is also guiding us to positively impact society and the world. We care about our communities we operated in. We are committed to engaging with local markets and giving back to the society. According to WTTC’s forecast, the travel and tourism sectors will generate 126 million additional jobs in the coming 10 years from 2022 to 2032, in which 65% will be in the Asia-Pacific region in general and 25% in China, in particular. This aligns with our ambition to help create job opportunities and contribute to the real economy. With corporate responsibility close to our heart, we continue to push forward with our rural revitalization initiatives in China to empower locals to build up a strong tourism and to pursue common prosperity. We currently have 13 Trip.com country retreats in operations across multiple provinces, including Anhui, Henan, Hunan, Jiangxi, Guangxi etcetera. We also established a multiple rural revitalization academies to offer professionals training to the locals. As a continuation of our Project B, which was launched in year 2020 when pandemic took place aimed to revital our global travel and driving consumption amidst the pandemic. We recently launched Project A as an upgrade. B stands for automating up and A stands for reaching a new peak. Project A is launched with strategies to rebuild our brand image and revive consumer confidence by improving our product and service offerings to reunite the industry by sharing knowledge and building industry incubation center and to reestablish the industry’s social and environmental responsibility by pushing forward our last project to promote sustainable travel. In overseas market, we also encourage users to think and act together to practice more sustainable travel. In South Korea, we held traveling campaigns by combining beach jogging and litter picking as part of our World Environment Day focus. We also launched a content campaign in our Singapore, Korea, Hong Kong sites for users to share their eco-friendly experiences. Trip.com was also named a champion for good in Singapore. In conclusion, we are delighted to see the world throwing their door open and moving closer towards normalcy and we are proud of the strong results delivered by our team under such challenging markets. We are glad to see further optimization in China recent COVID policy adjustments, which include largely scrapping the health QR code, dropping PCR tests, shortening quarantine period, allowing patients with no or mild symptoms to quarantine at home and removing circuitry mechanism on inbound flight routes that we will help restore the supply capacities. We believe these new guidelines will largely benefit the recovery of the travel industry. While we may still have to embrace uncertainty from the surge in COVID cases in the short-term, we are confident in the long-term outlook of the industry and opportunities ahead of us. Thanks, Jane. Good morning, everyone. For the third quarter of 2022, Trip.com Group reported net revenue of RMB6.9 billion, representing a 29% increase from the same period last year and a 72% increase from the previous quarter, primarily due to recovery in China domestic market and strong performance in our overseas market. Accommodation reservation revenue for the third quarter of 2022 was RMB2.9 billion, representing a 32% increase year-over-year and a 114% increase quarter-over-quarter, recovering to 71% of the 2019 level. This was mainly due to the resilience of local and short-haul travels, which are less affected by pandemic, and a brief recovery in long-haul travel following the easing of restrictions in July and August. While offsetted by viral resurgence in late August, the rapid recovery in our overseas market also contributed to our hotel business performance. Transportation ticketing revenue for the third quarter of 2022 was RMB2.6 billion, representing a 44% increase year-over-year and a 49% increase quarter-over-quarter, recovering to 70% of the 2019 level. This was mainly due to the easing of travel restrictions in July and early August that facilitated domestic loss for travel and was driven by the summer demand. Transportation ticketing performance quickly went soft for the second half of the quarter due to new rounds of virus outbreak since late August. On the other hand, our international business maintained its growth momentum and was rapidly recovering. Packaged tour revenue for the third quarter of 2022 was RMB387 million, which remained stable year-over-year and represented a 217% increase quarter-over-quarter, recovering to 24% of the 2019 level. This was mainly driven by the strong summer demand in the first 2 months of the quarter. Corporate travel revenue for the third quarter of 2022 was RMB317 million, representing a 9% increase year-over-year and a 76% increase quarter-over-quarter, 10% higher than the 2019 level, primarily due to the easing of relaxation of travel restrictions in July and August. Excluding share-based compensation charges, our total adjusted operating expenses increased by 15% year-over-year and with a saving of 22% compared to the same period in 2019. Adjusted product development expenses for the third quarter increased by 43% from the previous quarter and was a saving of 10% compared to the same period in 2019. Adjusted G&A expenses for the third quarter increased by 46% from the previous quarter and an increase of 4% when compared to the same period in 2019. These were mainly related to the increase in performance bonus paid to key operations and technology teams to reward their excellent performance in the quarter. Adjusted sales and marketing expenses for the third quarter increased by 76% from the previous quarter, mainly due to increased amount of marketing investment in China and overseas market to capture the strong recover demand. It was still a saving of 43% compared to the same period in 2019 as we continue to stick with our stringent cost control protocol. Adjusted EBITDA was RMB1.4 billion for the third quarter compared to RMB537 million in the same period last year and RMB355 million in the previous quarter. Adjusted EBITDA margin was 21% for the third quarter compared to 10% in the same period last year and 9% in the last quarter. Diluted income per ordinary share and per ADS were RMB0.41 or $0.06 for the third quarter of 2022. Excluding share-based compensation charges and fair value changes of equity security investments and exchangeable senior notes, non-GAAP diluted income per ordinary share and per ADS were RMB1.58 or $0.22 for the third quarter. As of September 30, 2022, the balance of cash and cash equivalents restricted cash, short-term investment, held-to-maturity time deposits and financial products was RMB62 billion or $8.7 billion. Turning to the fourth quarter of 2022, we would like to share some color on our business. Quarter to date, the domestic travel performance was soft due to viral resurgence and strict pandemic control measures. According to public data, industry level air passenger volume in October and November was 70% to 80% below the 2019 level. The hotel side was slightly better than the more resilient local and short-haul demand with industry-level hotel RevPAR 40% to 50% below the 2019 level. In such time of difficulty, we are glad to see our business continue to outperform the industry across segments, with local hotel reservations maintaining positive growth in the first 2 months in Q4. The announcement of updated pandemic-related measures in mid-November sends positive signals, and we were encouraged to see subsequent improvements in the domestic travel reservations. We are also happy to see the authority continue to soften its COVID rules in December with the dropping of health QR code and PCR test result checks before entering most public areas and traveling across cities, among other relaxations. Outside of China, the travel momentum in Europe and U.S. remains largely stable in this quarter to date. Despite uncertainties and challenges from a macro environment, our business recovery in the APAC, excluding China, also continues to accelerate, and we hope to see better performance in the coming quarters. While the world has been leaving COVID behind and gradually entering a post-pandemic era, we may still have to go down a choppy recovery path in the near-term as uncertainties continues to linger, and things are out of industry and company’s control. We will continue to stick with our spending protocol and cash flow management while I remain cautiously optimistic about the travel environment and be ready to seize any opportunity in the coming future. Good morning, management and team. Thank you for taking my question. Cindy, you mentioned that the world is leaving COVID behind. What are the changes you have seen in user behavior? And what did company do for the new normalcy? Also, you mentioned there could be an initial disruption period. Can you share with us your observation for Mainland China business in recent weeks? Thank you. Thank you for the question. We are delighted to see the global travel demand continue to be resilient even after end of demand has been released over the previous quarters. And the global travel markets continued to show strong performance despite macro challenges. We expect to see a similar pattern in China, and are confident in the strong travel desire of Chinese travelers in post COVID era. Travel preferences have been evolving over these years, and the new norms are emerging. For example, leisure and travel is on the rise as remote working become more accessible. Short-haul travel has also become a new preference for many users. There remains a huge growth opportunity in the leisure travel segment which has been our expertise in the past decade, and we continue to make achievements. With our local focus and global vision, we remain focused on strengthening our globalization strategy, penetrating into lower-tier cities, driving higher user engagement and stickiness, while also leveraging our content strategy and a one-stop platform to build a solid foundation for sustainable growth in the post COVID era. Yes. With regard to the recent booking trend, China’s recent optimization of the COVID measures is a significant step forward and quite encouraging for the whole travel industry. We actually saw a very strong sequential increase in domestic flight and hotel reservations in the past 2 weeks following this announcement, and the execution of this new measurement across cities. But in the very near-term, we are still cautious as winter is usually a flat season for both business and leisure travel. And it also might take some time for people to get through the first wave of infections before travel demand could fully release and rebound, but we anticipate to see a very nice rebound in growth in the domestic travel segment next year. Thank you. Hi, good morning. Thanks management for taking my question. Can you share more color about the domestic business recovery in Q4? In particular, how we should think about the domestic ADR and takeaway as well as how we should think about the international ADR and takeaway in Q4? Thank you. Thank you, Thomas. In the first 2 months of Q4, our domestic travel momentum was pretty much muted due to the spread of COVID cases and especially the very strict control measures. In October and November, industry air passenger volume was about 70% to 80% before the pre-COVID level with the help of comparably resilient local and short-haul demand. And the hotel industry RevPAR was still 40% to 50% below the pre-COVID level according to public data. But we are very glad to see our business continue to outperform the industry across segments in such a very difficult time. And our local hotel reservations maintained a positive growth in the first 2 months in the fourth quarter. With regards to the domestic – with regards to the ADR, ADR generally moves in the same direction of the overall travel demand, and our ADR has fully recovered to pre-COVID level in July and August in the summer and was down again starting from September. ADR remained below the 2019 level in the past 2 months. And the take rate has been quite stable. With regard to the international hotel ADR, the hotel ADR, our international platform are still recovering towards the pre-COVID level, but has improved significantly on a year-over-year basis, which partially contributed to the revenue recovery. Thank you. And maybe on the topic – yes, can you help us maybe break down the international performance maybe by brand, by product, maybe by region? And just give us a sense how much recovery are you seeing in the quarter? And how should we think about the revenue contribution coming from the international markets? Thanks. Sure. In the third quarter, the global travel market continues to recover despite headwinds in certain markets. In terms of the performance by our different products, as we shared in the prepared remarks, the overall air ticketing bookings on our global platform has increased over 100% year-over-year and recovered to 80% to 90% of 2019 level in the third quarter. Our non-Chinese hotel bookings on our global platform grew more than 45% versus the 2019 level. And reservations for our attractive tickets and in-destination activities on our global platform maintained a triple-digit year-over-year growth, which is 30% growth sequentially in the third quarter. In terms of the different regions, despite headwinds in Europe and the American markets, such as the shortage of air capacity and labor strikes in the summer, revenues from our EMEA and American markets remained well above the pre-COVID level. On a year-over-year basis, flight reservations maintained a high double-digit growth. And travel activities in the APAC region rebounded very quickly in the past summer with price reservations up 400% year-over-year. And both our air and hotel reservations in the APAC region are making solid progress toward full recovery to the pre-COVID level. In terms of the total revenue contribution from the international platform grew more than 140% year-over-year, which contributing about 15% to 20% of our total revenues in the third quarter. And the EBITDA margin of certain international brands have reached or even surpassed the pre-COVID level in the Q3, thanks to the continued revenue recovery and improving in the operational efficiency. Thank you. Thank you very much for taking my questions. Given the China’s reopening has been – the pivot has been very decisive and swift, I was wondering if you can share some of your thoughts about the outlook for Chinese New Year travel this year? Do you see it will be back hopefully? And any outlook for the outbound, which obviously is Chinese travelers haven’t been able to do much last few years, what do you think that spike is going to happen sometime by next year, how that’s going to evolve in your view in the next 12 months? Thank you so much. Thank you. So, the Chinese New Year is not a – the calendar New Year is not a big holiday in China. And due to the short booking window, the visibility for Spring Festival, the Chinese New Year reservation, at this moment, is still low. However, the search interest went up by three times – several times following the announcement of the new COVID policy. We are also seeing significant increase of reservations as well. But the current orders are not meaningfully to forecast the travel activity in Spring Festival just because of the very short booking windows in the past couple of years. And with regard to the recovery of the outbound travel, following the recent release of COVID policy optimization, and the message is that the authority will continue to refine cross-border related healthcare measures. I think it’s reasonable to anticipate further changes that will facilitate the cross-border travel. And many airlines also announced the plans to increase international flight capacity. And to-date, the average weekly inbound – outbound flight has more than doubled in the past four months to five months to about 10% of 2019 level, and will continue to grow. And furthermore, following the release of the new policies in November, the search volume for inbound and outbound travel skyrocketed in the subsequent days. Cross-border air ticket reservations in Mainland China also reached the highest level since 2020. To-date, the inbound and outbound flight reservations recovered to about 20% of the pre-COVID level. With regards to the outlook of our recovery, outlook towards the next year, we are encouraged to see the very strong rebound of travel demand in the overseas market in the previous quarters. And we believe it is the same case in China where travelers, especially the mid to high-end travelers, also have very strong desire to travel internationally. Thank you, management for taking my questions. Congrats on very strong results, the future outlook, and wish everyone keeping good health. So, my question is related to – so I think as things are getting reopened, we will get to normal very quickly. So, how should investors think about once we get back to 2019 level, the post-pandemic future growth outlook drivers? Thank you very much. Yes. So, for the future growth, we have seen very strong pent-up demand in the long-term. As soon as the government relax the policy, our site has a surge of the search for both domestic travel as well as international travel. So, for Trip.com, we look at domestic travel and international travel very positively. First of all, I think for the domestic travel, for people who are staying in the high-end hotels, value for money and also a comprehensive product offering has been very well liked by our customers who prefer to stay in the high-end hotels. So, that segment has enjoyed a resilient growth in the past, even during a very difficult time. Secondly, our team also penetrated further into the lower-tier cities to encourage the users’ engagement and make sure we are tapping to these untouched markets as quickly as possible. Thirdly, for international travel, because we offer a very high end of the comprehensive product as well as solid customer service, we are able to bring the customers who have the interest to travel abroad even during the lockdown. And with the relaxation of the travel, we have seen a huge surge for the outbound travel. And going forward, in the long run, that will become another very strong driving initiative for our team to capitalize on. So, overall, I think with domestic travel as well as international travel, the opportunity is very prevalent. So, our team is working very hard to strengthen our service products and also the technology infrastructure to build the infrastructure to enable our customers to see the best of the domestic attractions as well as the global attractions. Thank you. Good morning management. I just have one question. So, look at this quarter, both gross margin and operating margin achieved the record highest level. So, I wonder going forward, if you have a target for those two margins in the long run? Thank you. Thanks. So, there are two major parts of our – of our expenses side. One is on the people side. The other is on the sales and marketing. So, on the people side, the total headcount actually remained stable sequentially and even slightly lower in the Q3 on a year-over-year basis. And going forward, we expect our total staff level to remain generally stable, especially for the China domestic business, while the cost per headcount may change according to the performance of the company. On the sales and marketing side, we always follow a very strict ROI-driven investment protocols for our sales and marketing spending. And a large majority of our sales and marketing expenses is discretional. And in the Q3, we actually increased investment in sales and marketing activities in both the China and overseas market just to capture the very strong recovery momentum, especially at the beginning of the Q3. And our marketing spending in China will swiftly scale down in the second half of the quarter as the travel demand declined due to the emergence of COVID cases and as well as the strict travel control measures. Going forward, we will keep an agile spending protocol and be adaptive to the fast-changing environment just to swiftly capture the recovery opportunities and to retain resources in a tough time. In addition, actually, our improvement on our content offering, our app strategy and cross-selling and technology will also help us to – continuously to improve our marketing efficiency, especially in the long run. So, in terms of the operating margins, as we always explained, we think we have a very good business model. And when the business can return to a normal level, we can have a very reasonable and healthy operating margin going back to at least 20% to 30% level. Thank you. Good morning management. Thank you for taking my question. I want to hear your updated thoughts on the domestic competitive landscape because as the domestic travel market is set to recover next year, do we expect the competitive pressure to increase, for example, from other OTAs stepping up subsidies or from potential new entrants into the market? And if that happens, what’s our strategy to defend our market share? Thank you. Yes. So, for competitive landscape, I think our focus has always been customer first and our partner second. If we do both well, the results would show itself and we will stand out in the competition. So, what we have seen is a stabilized market with the pandemic, everything is easening out, and the market is very stable. However, we are able to capitalize on the opportunity in a couple of fronts. First of all, the same-city travel and short-haul travel is growing very well. And that is due to the pandemic. A lot of people are turning to travel within short distance in which they have more control. In that segment, our market growth is very strong. We have seen a huge pickup in that segment. Secondly, because [ph] of the offer will start shopping platform, we are able to cross-sell products within [indiscernible] use. And that is very efficient in terms of using [Technical Difficulty] to up-sell based on their strengths. For example, when they arrive in certain attractions, not only we are able to sell one product based on our understanding of the customer, normally, we will be able to help our partners in certain geographic area to up-sell for these products. And because Trip.com’s level attracts high-end, high-quality customers, we normally are able to help our sales managers [ph] to maximize their sales in the region. And thirdly is the engagement of users and customers on site. What we have seen is the enhancement of our product and content attracts more customers on to our site, and the user’s engagement is enhancing as well. If you look at the time they spend on our sites, it’s increasing every year. And user engagement, the interest for people to do research on our site and use our product to cross-buy different products on sites are also very significant. So, these are the strengths we have. And if we truly listen to our customers and always put their interest first and also help our partners to weather through the storm, we will be able to stand out in the competitive landscape. Thank you. Thanks management for taking my question. Just a follow-up to our overseas business. We have seen some challenges in macro environments in many markets. How should we think about the recovery or growth of our international brands in the fourth quarter and the next year? And how do you think the changing macro environment will change your strategy? And what will be the impact on your spending? Thank you. Yes. Thank you. Our growth of the international platform actually, we see – as I explained before, although there are some headwinds in the macro environment actually, we – so far, we didn’t notice too much impact on our overseas platform, both in the European e-mail area as well as the U.S. And maybe because we are still in the very early stage of our development in the overseas market, and the comparable base is very small, but I think as long as we can continuously improve our product offering as well as very efficient sales and marketing initiatives of sales and marketing spending, we will – we are very confident we can continuously to achieve a healthy growth in those regions. With regard to the APAC region, because the APAC region has just started to reopen and compared with earlier, we also have a very – a pretty strong product offerings as well as the brand recognitions in the region. So, in the next year, we think we have a very good opportunity to catch the pent-up demand recoveries in this region. So, overall, we are still quite optimistic on the continuously growth for our international market. Thank you. Hi. Thanks management. And I was wondering if you could share more color on your company’s strategy updates, especially on content? How would you process the strategy and what your expectations in the near-term? Thank you. Right. I was wondering how would you process the content strategy post the COVID lighting and what would be your expectations? Okay. Thank you. So, actually, the behaviors of our global travelers have evolved over the past 3 years from their travel preference to decision-making process. It is the goal of our content strategy to inspire and provide credible recommendations to empower travelers to discover the most unique things to do the eat and see around the world. So, in the third quarter, we continuously to improve our content generation and user engagement capabilities. In the third quarter, the number of content creators increased by 20% year-over-year, and the amount of daily average UGC content continued to grow year-over-year. For example, in September, there were 76% more contents being generated by our users when compared to the same period last year. With regard to the user engagement, the average view duration on our content platform increased by 8% year-over-year, and the average number of content viewed per user also increased by about 24%. The conversion rates of destinations-related content increased by 14% to – yes, to 44% in Q3 from the first half of this year. As there is no particular form of content that will always go viral, actually instead of pursuing creation of viral content, we remain focused on providing the most suitable and relatable content that can easily be accessed by users through search and features. This is actually why we create a Trip.Best List, which have bucket list of travel topics with credibility and authenticity as we believe professional, trustworthy and easy accessible recommendations plus one-stop service model will enable Trip.com, Ctrip to build a closed-loop travel ecosystem going forward. Thank you. Thank you for the questions. With that, I would like to turn the call back to Michelle Qi from the company for closing remarks. Thank you. Thanks everyone for joining us today. You can find the transcript and the webcast of today’s call on investors.trip.com. We look forward to speaking with you on the fourth quarter of 2022 earnings call. Thank you and have a good day.
EarningCall_1414
Well, good afternoon. And for those on our streaming site, welcome back to Citi's 2023 Communications, Media & Entertainment Conference. For those of you I haven’t met, I'm Mike Rollins and I cover communications services and infrastructure for Citi Research. Before we get started, I'd like to mention that we do have disclosures available at the registration desk and on the Citi Velocity page from which we're streaming the audio. We're also going to look to incorporate your questions in today's discussion. So if you're here with us today, we have a microphone in the back. And if you raise your hand later during our discussion, I will try to get back to you. If you're streaming, you can enter the questions directly into the box on the page and we are going to continue the tradition of using live surveys and so they are completely anonymous. We're just going to share the full aggregation of the responses and you can access that here with the QR codes that you can see on the placards and on the boards here and on the site it should come up as we're discussing the live polls and you can enter your responses that way. So with all of that out of the way, I'd like to welcome back Peter Osvaldik, CFO of T-Mobile. Peter, thanks for being with us. Mike, it's just such a pleasure to be back here again and I'm looking forward to the conference and what a beautiful place. And let me start with the legalese. So today, I may make forward-looking statements subject to risks and uncertainties, and refer to our SEC filings as well as non-GAAP metrics, and all the reconciliations are there for you. So you've got some news out after the close. We'll get to that in just a moment. Before we get there, though, just set us up at a high level in terms of how T-Mobile is thinking about the strategic and operating priorities for 2023 and how they might be different than 2022. Really, it's a continuation of what we've been doing to date, Mike, and that is to continue to drive industry-leading customer growth and doing it in a profitable accretive way. And when you kind of double click down on that, the first stage in that is continuing this uncarrier journey that we've been on of being able for the first time ever in this industry to bring in the same company the best network and the best value and drive that proposition in. And so of course, that starts with the network, and we're going to continue the evolution. We've been ahead on 5G for quite a bit of time now. That's going to continue to be a durable 5G lead. But what's more and more interesting is as 5G becomes DG, that 5G network leadership is translating into overall network leadership. So we're going to continue on that journey much as we have been in 2023. The second is really working on our differentiated growth opportunities, and you've heard us talk about these time and time again, but we're going to continue to focus in on those that's top 100 network seekers, for the first time ever because of this network, being able to drive network seekers to T-Mobile, even in the markets where we have a leading market share because of the value proposition that we've been able to bring over many years. Second is smaller markets and rural areas, 40% of the population where we've made significant inroads and we'll continue to work there. T-Mobile for business, I'm excited to dive a little bit deeper into all of these, but has been on a great journey in Q4 had another great set of results for T-Mobile for business, and of course, fixed wireless or high speed internet as we like to call it, where we delivered yet again in Q4 tremendous adds right at the pace that we wanted to be and will continue into 2023. And the last, really the last piece of the integration in 2023 to be able to set up not only what we think will be the world's most successful telecommunications merger in history, but to be able to get to full synergy run rate in 2024. Well, that's really it. Great. So let's jump into the fourth quarter results. So you shared some metrics, maybe share some highlights and maybe get some context of what drove your performance during the fourth quarter? Yes. Well, it continues to be, as I said, at the highest level, it is the ability to bring the best network and the best value. And bringing those together as well as leveraging these underpenetrated markets that we have is what drove the growth. And what's interesting at a high level, the industry, certainly Q4 to Q4 in 2022, we've started to see some of the normalization from those very high peak levels of growth in 2021 and we saw that happen in Q3. Certainly, based on consensus for everybody and our own internal projections, we'll see a continued decline in net add growth vis-a-vis Q4 of 2021 and Q4 of this year. But despite all that, what we just delivered in Q4 was actually our highest postpaid phone additions since the merger, 927,000 postpaid phone net additions for the quarter and 1.8 million total postpaid connections. And we'll get into how important in the era of 5G is growth beyond just postpaid phone, 314,000 net account editions. Remember that the true measure of switching we delivered yet another tremendous quarter there and 524,000 high speed internet connections. So continuing on the journey, that has just really taken off this year in a phenomenal way. There was questions as we were exiting the fourth quarter, whether inventory constraints of smartphones would hold back sales in the quarter. Did you see any of that? Is there some spillover effect that investors should expect for T-Mobile in the first quarter? Yes. Certainly, what we saw was during the quarter, I mean, well documented some shortages and issues with some of the higher end handsets. But by the time you got towards the end of the quarter, we saw a lot of that normalized. Did it probably have a little bit of impact? You know, being the switcher taker in the industry probably impacts us more than perhaps others. So in the period of the quarter, maybe there was a little bit of an impact. I don't anticipate there was a lot of spillover because a lot of that got healthy by the end of the quarter. And how do you rate the overall quality of the volume? Like if you look at the rate plan mix on Magenta MAX and you look at it relative to the last few quarters or what's in the base, can you help us appreciate the quality of these adds coming in? Yes. Well, that's just such a fundamental aspect of how we approach every single quarter as I said, all year and what our priority continues to be into 2023 is not only driving industry-leading growth, but also making sure that that's done in a profitable accretive way. Every single quarter you can drive more gross adds and hence more net adds, but you're doing it at much less CLV on a per customer basis. So that's not our goal. Our goal is always, this is the growth that we want to deliver and make sure that we're do doing it in a very accretive, profitable way and that's how we approached Q4 as well. And certainly, being able to deliver a now record Q4 postpaid phone churn number helped that number and helped that balance as well. But that's how we think about the growth. Magenta MAX continues to be tremendously strong. In Q3, we talked about of new accounts coming in, it was at above 60% near to above 60%, that continues into Q4. In terms of the base, in Q3, we were just shy of 20% and we'll disclose more towards earnings, but we continue to see strength. And one of the interesting things, we launched a 4 for 100 promotion. And what we saw there is exactly what we thought we would see. It drove incremental traffic to the digital properties into the stores. But once people got into the stores, and once their consideration is set and they see the value prop of the network and the value prop of Magenta MAX, we saw tremendous conversion into higher tier rate plans. In fact, that 4 for 100 mix loading, that represented less than 1% of our activations in Q4. So you just saw how people came in. It drove the traffic, drove the demand, the interest, but then stepped up into higher tier rate plans. So first survey question coming up. How many postpaid phone subscribers will T-Mobile add in 2023? 1.5 million or less, 1.5 million to 2 million, 2 million to 2.5 million, 2.5 million to 3 million and over 3 million? So we'll come back and see what our audience thinks. But before we get there, and of course, Peter, we're going to welcome your opinion on this. But before we get there, are you seeing any changes to the competitive landscape? You talked about churn coming down, so maybe talk about competition, cable, dish, and how that's -- how that is or isn't affecting what you're seeing on the churn side. Yes. Well, certainly, you see seasonality from a promotional intensity perspective. Q4 is always promotionally more intensive around the holidays to drive switching. And the competitive intensity really continues at the same level we've seen, whether it's cable, whether it's the other competitors. They've been in the run rate, they've been doing things. The difference for us is that because again, we're driving this 5G network that's leading to overall network leadership, and it's becoming slowly and consumer perception, it's changing. Over the course since the merger, we've changed the perception of Verizon's network leadership and the consumer space by half, we've cut that by half. And we're rapidly approaching the point where consumers believe that this is the best network. Business customers buy differently. We've spoken about that. They actually test, and we're seeing a lot more traction there. So this actuality of the network is now translating into perception. That combined with these underpenetrated markets is what gives us a differentiated opportunity. And why even in the face of more normalization from the period of very high net adds that we saw in 2021 and we think postpaid switching is probably down about 5% to 6% relative to last year. Again, net adds, we project will be down relative to last year's high, and yet we just delivered our best postpaid phone quarter since the merger and delivered the lowest churn. And that is because it's really the value proposition and the network proposition. So that's how we approached it and its growth across all of the growth segments that we've talked about. That's why we're in a very differentiated place. And we expect 2023 will continue to see normalization of net add growth, but we continue to be positioned in a way that allows us to compete and deliver industry-leading growth in a profitable way despite that happening. Let's see the results of our survey. So 8%, 1.5 million or less; 17%, 1.5 million to 2 million; 33%, 2 million to 2.5 million; 29%, 2.5 million to 3 million; and 13% over 3 million. Well, great set of results. Of course, we'll guide on customers in a few weeks here when we come to year-end earnings, but I couldn't be more pleased with 2022 at 3.1 million postpaid phone net additions in the quarter - or in a year, sorry. How - when you said growth could normalize in 2023, what does that mean for industry postpaid phone net adds, like what's the baseline that kind of T-Mobile is thinking about for normalization? We run obviously as you'd expect a plethora of scenarios and our job is to really think about sensitivities and what do we see the industry is doing. You are probably going to see somewhere in the order of 9 million this year. We think it's going to be lower than that. There again, we've probably weighted certain scenarios. So I don't have a pinpoint number that we said that's the number because we look at multiple scenarios, but I think it's going to be lower than that. One of the things that's really evolved this year for T-Mobile was ARPU growth. And as you look at the Magenta metrics you were sharing with us earlier, can ARPU grow again in 2023? And is there anything on the integration side or other factors that might affect that? Well, from an integration perspective, as you know, we did the vast majority of our rate plan mapping, and that was really in an effort to get the Sprint customer base mapped into rate plans that then could be part of this streaming conversion and we can get into kind of the last stages of integration a little bit later. There's a little bit left to do with some bespoke business plans that will be a little bit of a headwind to ARPU, but it's very immaterial. More importantly for us, as we've been saying for a while, we are here to capture the switcher relationships, and you saw that in Q4 and of course full 2022 postpaid net account additions. And, but more importantly, in the 5G world, with the opening of more connected devices with high speed Internet or fixed wireless, our focus has been drive the account switchers in and then expand ARPA and because ARPU becomes a mix-driven metric. For example, the more success we see in large enterprise and government, of course, naturally, they tend to have lower per unit ARPUs, but they have high CLVs. And so while you may have more success there in a quarter versus the last, that may have ARPU impacts, but our focus is service revenue growth through both industry-leading customer growth as well as accounts and ARPA growth, that's what we're focused on. And as you look at the account growth that you were describing earlier, are there any of the underpenetrated segments that you've detailed today and in the past that really stand out was it rural, was it business, certain things that just really stood out in terms of the success of the quarter? No. The beauty of it is, it's execution across all of those fronts. So we continue to see between top 100 and smaller markets and rural areas. In Q3, we said it was roughly split 50-50 from an net account addition, and we continue to see about equal metrics in Q4. You have high-speed Internet only, which is not only just a way to bring in bundled products and bring in and pull through phone, but a way, especially in smaller markets and rural areas as the network is being built out and really coming in with a differentiated product, a way to change people's perceptions really quickly about the product. So we do have a slew of high-speed Internet only accounts that then opens up the opportunity to sell phone into. And then T-Mobile for business just continued to have a great Q4 and Q3. We mentioned that both from a postpaid phone and net account - or postpaid phone addition perspective, as well as a postpaid phone churn perspective, Q3 was one of our best quarters ever. And on both of those metrics, Q4 was better than Q3. So that growth there in T-Mobile for business continues to do really well and across all the segments, micro, SMB, enterprise, government, everywhere we're focused. So it's -- that's the beauty of the machine and why despite maybe normalization from the high, again, why we have a differentiated opportunity to continue to grow at very profitable levels in an outsized manner. All right, let's go to the polls. So, and we're going to come back to the subject in a few minutes. So how many fixed wireless broadband subscribers will T-Mobile add in 2023, 1 million or less; 1 million to 1.5 million; 1.5 million to 2 million; 2 million to 2.5 million; or over 2.5 million? And we'll see how people respond to that. But before we get to fixed wireless, you mentioned the integration and maybe getting any of these last phases, what's entailed in these last phases and what does that mean for the pacing of synergy realization? Well, first I'd be remiss not to brag just for a second about the team and what they've done. I mean, we've already announced it, obviously, but getting the cell site decommissioning done, not only ahead of schedule, so about a year ahead of the original merger plan and about three months ahead of where we thought we would be, even when we gave Analyst Day guidance, was just a phenomenal success. And doing it in the backdrop of the churn figures that we delivered is probably the most impressive thing that the team, Neville and Olaf and team have done spectacular work there cross-functionally. So that's really to me the number one thing and something to be tremendously proud of. What remains, as we've said is predominantly billing conversion. And the way we designed this integration from the onset is we disconnected the network migration from the billing migration, from the brand migration, and we effectively mapped or groomed customers to their destination rate plans. We talked a little bit earlier, there's still a little bit of work to do on the small subset of business bespoke plans on the Sprint biller, but we'll get through those. And then as we're building the functionality in the Magenta biller to match the functionality in the Sprint biller, and what we then have is basically very seamless, what we call streaming conversion of the accounts, and they go from one biller to the other. You get a, hey, welcome, now you're part of the T-Mobile biller, and it's very seamless to the customer, which is in an effort to make sure that we're not driving irritants in churn that's already happening at pace. And we anticipate as we finalize all the build of the capabilities, that will be the last big piece that's done at the end of 2023. There's other smaller things. With the biller migration, you get the full suite of customer care that we have. Not everything is built into the Sprint biller, and of course we're going to get through the balance of the least device constructs onto our EIP financing constructs, which is more customer friendly. But that's, that's basically it and it's been just a tremendous success. We anticipate wrapping this up in 2023 and can't be more proud of the team. So given what you're describing on the synergies being ahead of schedule, and I think in the past the management team has also talked about being ahead, what does that mean for the multi-year financial guidance? Does that mean that that puts T-Mobile in a position to outperform those original multi-year expectations? Well, again, we're on track to deliver the increased 7.5 billion run rate synergies and do that in 2024. What we saw in 2022 was that ability to quicken the network decommissioning gave us in year benefit and you know, that flowed obviously in Q2 and Q3 to the bottom line. And because we are three months ahead of schedule, we'll get a benefit in 2022. But exiting 2022, we effectively thought we'd be in the same kind of exit run rate space. So for 2023, we think it's going to be exactly where we anticipate, and we'll guide this as part of earnings for where we think synergies are going to be on our path again to the 7.5 billion in 2024. What's happening on the macro front in terms of, are you seeing any changes in customer behavior, tier downs, changes in payment behavior, anything that give you some indications of a changing economic climate? From a customer perspective of course the period of the pandemic and the stimulus funds brought involve churn and bad debt levels across the industry to phenomenally low levels. I mean things we hadn't seen before. We had mentioned on the Q3 call, what we saw was a return of involve churn to pre-pandemic levels, and we continue to see that. In fact, Q4 was just a touch better than Q3. So we’re not seeing anything there, remember, and these were pre-pandemic levels for us in the 2019 timeframe that were kind of our best in company history. So we’re seeing a return to that. We continue to see about that level. We certainly aren’t seeing anything with respect to rate plan migrations. We talked about the Magenta MAX take rate continues to be tremendously high. So all of that seems, right, of course we’re very cautious about this and looking at this every single day. We have as many times we’ve talked before because of our history and ability to work with variable income customers in a way that others probably don’t. That said, throughout the balance of the last couple years because of the network and because of what we’ve built, we’ve also attracted a tremendously higher amount of prime consumers into the base. So it’s an improvement in terms of the prime consumer mix. It’s our ability to work with variable income consumers, and then we’ve seen exactly what we thought last quarter, which is, yes, kind of where we turn to that pre pandemic level but nothing worse. What about on the cost side and inflation side? How are you managing that? Is that an incremental headwind in 2023? Well, this is another place where we’re a little bit differentiated in and in the biggest areas of cost in the business, we’ve been able, before this macroeconomic and inflationary environment hit, we’re able to secure long-term agreements. And we needed to do that as part of the merger, both with our OEMs as we went through a very massive network rollout and CapEx is going to step down in 2023 relative to 2022, which was the peak here for us, as we had said. So we locked those down. We locked our two big tower vendors down into long-term agreements with just tremendous rates including escalators in one case that actually escalate down and a period when inflation was low and so those are probably contracts that wouldn’t be able to be executed today. All of our debt is fixed rate. You know, a lot of our energy contracts are in PPAs and BPPAs about two-thirds of them, so that effectively locks them. But of course we’ve seen it and we’ve talked about it. We’ve seen it on the edges. We’ve seen it with labor. We’ve seen it with bad debt. We’ve seen it with some of the smaller component vendors that we didn’t have in long-term arrangements, but that’s all embedded in the guide that we had given for 2022. And while of course on the edges it’s a headwind for 2023 for us because of that ability to lock those big vendors down. I don’t see it as a big headwind for us. Just a follow up to this and then we’ll get into the fixed wireless discussion. So previously in the multi-year guide, I think the objective was to get CapEx to $9 billion to $10 billion in 2023, but you had strong growth, not just in mobile, but in fixed. So does the demand environment and the revenue growth that you’ve experienced impact how you look at CapEx for 2023? Well, I’m going to resist the temptation to give you all the guidance for 2023. But on the CapEx range, we currently still see the 9 to 10 range as being the right range for 2023. Again, we hit -- you saw us pull forward from outer years into 2022, some of the network build and deliver on just tremendous results 260 million covered pops on mid band and now 323 million on low band 5G. So that’s been an incredible result and we’re going to see that step down. That was the peak here of intensity. We’re now on our way to achieve, roughly that 300 million covered pops on mid band in an approach that’s very customer driven. Customer driven coverage is what we’re saying, but 9 to 10 feels like the right range currently. So let’s go to the survey results and move over to fixed wireless. So in terms of the number of new subscribers at T-Mobile can add in 2023, 3% is a 1 million or less; 24% is 1 million to 1.5 million; 48% is 1.5 million to 2 million; and 24% is 2 million to 2.5 million. And so maybe talk about what’s driving your fixed wireless growth right now and how you see the opportunity to continue to increase subscriptions for this business? Yes, absolutely. So as you know, for us the model is a little bit different with fixed wireless. It’s an excess capacity model because of the massive amount of network capacity that’s being built here and we’ve used many different analogies. My favorite one from Neville is the expressway analogy where we went from one lane and we’re on our way to a 14-lane highway, we're now at about 7. We’re about halfway through that, when you think about both the breadth of what we’ve rolled out, but also the depth of spectrum. We’re at about 120 megahertz rolled out of mid band spectrum right now on our way to 200 megahertz by the end of 2023. So that creates a tremendous amount of capacity, an amount of capacity that’s just not even with our projected growth in postpaid phone and other connected devices, growth in terms of the subscriber growth as well as the per unit growth in data. And we had long ago pre-merger hypothesized how much data growth on a per device unit was going to go and it’s going about how we anticipated. So we look at every sector on our site, on a sector-by-sector basis we're modeling out what the projected growth is from postpaid phones, which is, what we’re protecting at all costs. It’s our highest CLV product. And looking at all the other connected devices and saying all of that cannot fill up the capacity that we’re generating. That’s when we’re approving, households in those sectors to sell fixed wireless. So there’s a couple of things that are happening. One is more of the network and more of the spectrum is being rolled out. So that’s going to continue to increase the amount of available homes that are able to purchase the product and that’s going to happen throughout 2023 and beyond as this build continues. The other is we’re seeing growth across the board. I mean we -- it’s definitely been majority consumer for us at the moment, but business continues to increase their growth of the high speed internet product. We’re seeing it spread across rural and urban. Again, I would suspect the mix will shift a little bit more to the rural and suburban or the smaller markets and rural areas as that network build continues to progress there. But that demand is fabulous on this product. You know, when you look at the NPS scores, yes, there’s a number of them out there, I’ll quote HarrisX for a moment, which puts us 30 points above cable and even 10 points above fiber. And so you’re seeing the tremendous demand. And we did something fun as you would expect, we always try things and this is a growing business. And one of the things we tried in Q4 given the holiday season and the promotional side of it is our $25 bundled offer. And again, much like on the postpaid phone side from the HSI side, it was a small minority of activations that actually took that $25 rate plan. And the hypothesis on the test was, could we pull through more phones as well? So we have a certain flow of high speed internet only accounts that presents great opportunity for sales in the future. Well we tested this, again small minority of activations actually landed on that $25 rate plan, but we did see some interesting incremental phone pull through. So the demand for the product is really strong. The NPS scores prove that out. And as more capacity continues to build, this is right about the pace that we want to be in that 500,000 market quarter. Well, that rolls right into our next survey question and so I'm going to ask our audience, does T-Mobile need to incrementally invest in fixed and mobile convergence? And the choices are, nope. T-Mobile should remain a wireless pure play for connectivity. Yes, T-Mobile should invest in greenfield fiber access, including the bead program. Yes, T-Mobile should partner and invest with regional telcos, or yes, T-Mobile should begin purchasing regional cable operators. We’re going go to the polls, but before we get to this topic let’s touch on prepaid. What’s going on in the prepaid segment, both in terms of the retail business, and then what do you see on the wholesale side in terms of, do you have more visibility with the roll off of TracFone and Dish? Yes, well let’s start with prepaid. At an industry level, certainly prepaid has been more challenged in 2022 and year-over-year we think Q4 will be down from an industry perspective, from a switcher perspective, close to 30%. Despite that we have one of the largest prepaid brands, we continue to show growth. And you saw that with our Q4 results. We had a fabulous year of growth. We had our lowest year of prepaid churn in the company’s history. So we’re very pleased with how Metro is going despite what’s happening there. And I think, you see cable's success. It’s a little hard to dissect their postpaid phones because what they disclose is total postpaid, not actually postpaid phone, but as we’ve said before, we’re forecasting that certainly Charter will probably have its best quarter ever. But most of that flow seems to be coming from Verizon and prepaid. And I think when you look at their pricing constructs, it’s very analogous sometimes to prepaid. So I think as an industry, that’s where prepaid is seeing some flow share go. There’s definitely flow share from prepaid into postpaid as well. Although for us, prepaid to postpaid migrations were actually down year-over-year. So we delivered that 927 at despite actually being lower. So I think that’s what’s happening in the prepaid market, but we continue to be very pleased with what we’re seeing with Metro by T-Mobile as well as some of the T-Mobile connect brands. On the wholesale front, our strategy has always been and will continue to be finding partners that complement us, right? We’re not interested in just competing in the same places. Do they have a different customer segment that perhaps they can bring a differentiated strength to? Do they have different distribution? That’s how we approach and think about wholesale relationships. On the revenue side, for TracFone that 750 million that we referenced back on Analyst Day, we had assumed would be and we still expect will be effectively gone by the end of 2023. And then with Dish you saw us enter into a multi-year agreement that has revenue minimums, albeit at lower levels than what we had forecasted at Analyst Day. And, no changes there since we had spoken about that in the last couple of quarters. So let’s go to our survey responses and 42% of our respondents said no, you should stay a wireless pure play 19% actually. So the next three responses are split almost evenly at 19% between the greenfield fiber access, partnering and investing with regional telcos, and beginning to purchase regional cable operations. How are you looking at the importance and or urgency of having a greater fixed to mobile converged offer in the marketplace? Well and you sort of asked about it in two different ways and we think about it in two. One is we’re continuing on our path of fixed wireless and high speed internet and achieving that 7 million, 8 million target. And again, that’s right around this 500,000 run rate, we’re on pace and that’s our goal and that’s embedded in the Analyst Day plans. We have spoken about looking at, are there circumstances under which we might invest incremental CapEx for incremental fixed wireless customers? All of that would have to be accretive to what we gave you at Analyst Day. And that’s something we’re investigating but have no conclusions for. With respect to fiber it’s really the same as we’ve been saying for the last couple quarters. We’re open-minded, we’re open-minded in terms of would there be a way for our brand, our distribution, our customer relationships to create a value proposition there that might make sense from an investment perspective, whether it’s partnerships or direct investments? Again, that would have to be accretive to what we gave at Analyst Day, but we’ve made no decisions there at all. But as you’d expect, we’re investigating it. That’s what you do as pay us for as a management team is to make sure we’re looking across the horizon and making the right decision. And what that is, it could be pure play, it could be a little bit of investment, it could be nothing. I don’t know. We’re looking at that, no conclusions yet. What’s the -- when you look at those possibilities, what’s the end goal? Is it just to simply sell more wireless or there’s some other opportunities that you’re looking at in terms of testing this fiber model? Again, I think your hypothesis that we’re much further along in the process than we are because we’re just looking at things and understanding. For example, one of the things you could ask yourself is with your brand, with your distribution, with your customer relationships, could you achieve higher penetration rates than a standalone fiber player? Maybe, maybe not, right? You’d have to convince yourself of that. So that’s something you could look at potentially. But again, these are things, we’re looking at a high level. We have some fiber pilots as you know. So we’re understanding some of the dynamics there, but those are the things you’d look at. And when you think about capacity, whether it’s for mobile, whether it’s for fixed wireless, so when you started the process C-band wasn’t out there, CBRS wasn’t out there, right? So there’s more spectrum that’s out there now. Maybe millimeter wave, it was I’m not sure if that was a defined part of the opportunity. Is there a much more expansive opportunity for T-Mobile in fixed wireless because of the deeper spectrum position you had today relative to when you started the merger? Potentially, again right now our focus is build out all the tremendous capacity because as you said, it was always Neville’s famous layer cake, but millimeter wave was always going to have a place in very dense urban environments or venues. I’m not interested in spending. I don’t know how many billions of dollars of CapEx to put millimeter wave nodes everywhere and drive 1% of my traffic on it. That’s not what the strategy is. It’s not efficient. I can’t help myself sometimes, sorry. But the focus really is how do we drive this plethora of spectrum out there for the benefit of the consumer bridging the digital divide, driving these underpenetrated growth opportunities for us? And then if it makes sense to incrementally invest CapEx densify maybe with C-band which we bought some of in very dense urban environments where it makes sense to deploy potentially over and above our 2.5 portfolio maybe. But again, all of that would have to be incremental to what we’ve given you at Analyst Day in terms of targets and service revenue, free cash flows, et cetera. Last survey of the afternoon, how much do you expect for T-Mobile share repurchases in 2023, 10 billion or less; 10 billion to 15 billion or over 15 billion? So we’ll go to the polls on that. Before we just talk about capital allocation in terms of free cash flow or buybacks, any updates just in terms of how T-Mobile is viewing target leverage levels? There’s really no update, very consistent. We believe the right place for us to be is in that mid two space and in the midterm itself. So that’s the focus and the goal. It’s completely consistent with where we are from an IG perspective. You’ve seen us diversify some of our funding sources that you'd expect. We entered the asset backed security market with our equipment installment plan receivables. So it continues to be, we want to stay at a very healthy level of leverage. We’re continuing to grow as a company. We continue to see the free cash flow generation potential that we laid out at Analyst Day, but it’s always going to be with a healthy leverage mindset. We’ve got our results in and so 10% is 10 billion or less; 60% is 10 billion to 15 billion; and 30% is over 15 billion. So just a couple of questions on this, how does the rate environment, just higher rates affect the pacing of share repurchases if at all? And is there any updates from the guidance that you gave for fourth quarter in terms of share purchases? Well, I think in terms of guidance on share repurchases, we’ll probably update you, as part of or actually on results we’ll update you as part of earnings. In terms of what’s been authorized, continues to be an authorization of up to 14 billion through Q3 of next year. Anything beyond that would have to be authorized by the Board. We still see confidence in the path of up to 60 billion, which is based off what we expect from a leverage perspective. From a free cash flow generation perspective we continue to have line of sight to that. But anything beyond the 14 billion would be at the Board’s discretion. And I’ll update you on actual’s as to what we’ve, repurchased. You heard us through October 20th have 1.5 billion. We had been authorized for up to 3 billion in 2022. We’ll give you actuals a little bit later. I don’t want to get into the, like the day-to-day of, how we’re thinking about share repurchases and volumes. Of course, you have to factor in the rate environment, right. Now I would tell you where the rate environment sits currently vis-à-vis what we believe the shareholder return potential is and where we think the stock price is going based on our belief in the trajectory of the business. It continues from our perspective to make sense to do, but if certainly if interest rates get to some sky high amount, you always have to factor that calculus in. Yes, that was the, it was the -- the Board authorization was up to 14 billion through the end of Q3 of 2023. And that was inclusive of the up to 3 billion in 2022. And then just a last question, how do you think about dividends versus repurchases? Is that something that you’re thinking more about in terms of creating just a regular dividend distribution for investors? Yes, it’s something we’ve talked about. We think right now, this form of shareholder return makes sense for us. We continue to be a very high growth company that continues to be our aspiration into 2023 strategically and beyond and delivering on the commitments that we’ve given you. Is there a potential in the future? Maybe for a dividend type of structure, but we have to see how things evolve. Of course, that would be fully at the discretion of the Board, but for now, the share repurchase path we think makes a lot of sense and that’s how we’re going to continue for the time being.
EarningCall_1415
All right. Let's go ahead and get started. Good morning, and thank you for attending JPMorgan's 21st Annual CES Semiconductor, Technology and Automotive Conference. My name is Harlan Sur. I'm the semiconductor and semiconductor capital equipment analyst for the firm. Very pleased to have Carlos Bori, Senior Vice President of Sales and Marketing for Skyworks. We also have Mitch Haws, Vice President of Investor Relations here with us today. I've asked Carlos to start us off by spending a few minutes describing what the team is showcasing here at CES, given that Skyworks is a leader in cellular and IoT connectivity with growing exposure to the automotive and industrial and infrastructure markets. So gentlemen, thank you for joining us today. And Carlos, let me go ahead and turn it over to you. Okay. Thank you very much. I appreciate the opportunity to speak with everybody today. It's always great to begin the New Year at CES, a terrific opportunity to get things going in the right direction. And as always, we have some interesting demonstrations and releases plan for the industry this year. And if I were to highlight a couple, I would start with the automotive segment, where we're showcasing our automotive-grade complete RF front-end system for 5G, inclusive of all the low, the mid to high bands, the ultrahigh bands for 5G, all supplied by organic -- vertically integrated Skyworks technology, and we can talk more about that throughout the presentation. But we're also highlighting in automotive, our power isolation portfolio, which is used for battery management systems for motor-drive, inverter traction. It's also used for battery management systems onboard chargers, among other applications and also timing solutions for automotive. With all the new cameras and the LiDAR that you're seeing in these new cars, you're sending tens of gigabits per second of data around the cabin and our timing solutions are being leveraged for those applications as well. In infrastructure, you'll see that we're -- we have a demonstration for our AccuTime and NetSync clock and timing portfolio, really initially generated for cloud applications, and we can talk about that, too. But as the industry transitions to 5G core infrastructure, unlike today where you're mostly using a 4G core and you're getting data on the 5G path, to really leverage the true differentiating attributes of 5G, which is the extremely low latency, the ultra reliability and the massive machine-type communication potentiality, you really need much more much tighter clocking solutions that are synchronized at the endpoint, at the base station and all the way back to the network. So this is greenfield opportunity for us. We're just starting to see the revenue from design wins with the top 3 suppliers you'll see debt demonstrations about that as well. We're also going to showcase our new HBT gallium arsenide process for the base station wireless infrastructure, an industry that we've been supporting for years. You'll also see some interesting things in audio. And again, you'll see the timing solutions that are gaining traction in the market for cloud and data center applications. Perfect. That was a great overview. Thank you for that. So if I look at the overall business looking into this fiscal year, calendar year '23, the smartphone market is looking to be flat to down 5% in units. Auto and industrial trends, although still relatively strong, looking to potentially weaken given a muted global macro environment. The team seems very confident that they will continue to outperform the market given content gains, strong design win pipeline. So help us understand how you're thinking about 2023, right, segments that are going to be weaker and dynamics that will continue to remain strong within the Skyworks business. Okay. I won't spend too much time on smartphones, but I feel like I have to hit on a couple of points at least. We began this cycle a couple of years ago, and we benefited from a significant growth in FY '21. But we've also continued to grow our revenue with our number one customer through the next phone and then the phone after that. And we continue to expect growth at our top customer in the years ahead. I'd also like to point out in the smartphone industry that we're still in the midst of a 5G transition. You're still seeing a portfolio at Samsung, at the top 3 China suppliers and other manufacturers ship to 5G. That's a tailwind for us. We don't do business really in 4G anymore. And then finally, there are significant trends in complexity and performance that are still driving innovation every upgrade cycle, every new platform, people didn't expect to see satellite communications and phones this year. People didn't expect to see as much uplink transmit, dual uplink transmit last year and this year. So there's still significant trends that encourage us to believe we can continue to grow in the smartphone space. But beyond smartphones, I talked about automotive a bit. We're well over $200 million run rate there. It's a healthy mix of 5G RF technology as well as power isolation and timing from the acquisition from Silicon Labs. I'll try to move quickly here, but we knew we would have a differentiated approach in automotive because the requirements are so stringent and we controlled the process technology, we controlled the assembly and test technology, and we could provide a more credible story in terms of supply sustainment and performance over temperature, et cetera. We do our own gallium arsenide, the wafers are produced in suburbs of Los Angeles and Boston, Massachusetts. We do our own test and assembly in Mexico, we leverage our IP and co-develop new processes and key technologies like SOI and CMOS. And we pull all of that complexity together in custom modules that we control. And so the uptake on 5G RF in the automotive industry has been actually better than we expected. And then on power isolation, that's going well, too. Our alpha customer or Silicon Labs is alpha customer, was the number one EV producer here in North America. We have low teens content and growing, and we're benefiting from unit growth at that customer. But we're also supplying that technology to BYD, the unit leader in China to Volkswagen, other unit leaders like Hyundai and Toyota, Nissan, the luxury brands in Germany. It's really just been a game of meeting the capacity requirements in '21 and '22, and we still are unable to close the gaps here in '23. It's not just a content story, but it's also an EV unit story as well. And then in ICE, everything is going to 5G and the timing requirements and ICE cars are just as stringent as they are in EVs as the automation trends pick up. In the broader IoT space, we're seeing a huge uplift as the world transitions from WiFi 6 or WiFi 6E. We're well positioned as a partner with Broadcom. We did a press release a few weeks ago. We're seeing an upgrade cycle in 6E now. It's affecting carriers, commercial, consumer and enterprise applications. It's even helping us in the smartphone space because as you double the available spectrum and you add more than what we had before in 2 and 5 gigahertz, and you cram that all between 6 and 7, these are all right next to the 5G ultra-high bands, making the performance requirements in smartphones, high too. But we're putting more PAs, more switches, more attenuators, more BAW filter technology in all of our WiFi components as well, the big routers that service a hub in your home and in your offices but in all the endpoints as well. So we expect that business to continue to grow year-over-year. And then generally in IoT, both fixed and mobile, people are down in the PC space. And I get that because units are down. But for us, it's a growth segment this year because the attach rate of 5G wide area network is outpacing the declines in units. And we can say that about a lot of spaces because ultimately, that's a business that we're in unwiring a lot of these applications. So if you look at automotive, if you look at I didn't say anything about the infrastructure or cloud. We're expecting to continue low double-digit CAGR extending -- actually, it will be a slow down this year compared to last year, but still double-digit growth in our timing portfolio for the data center and cloud applications as well. So if you eliminate the Android headwinds that we're going to continue to see, we're very positive about our outlook in calendar year '23. So many of the trends that you talked about are inside of your broad markets business, right? And you've driven great diversification. It was 36% of your revenues in fiscal '22 as you mentioned, automotive, IoT, industrial, data center, comms infrastructure, aerospace and defense, right, it's driven, I think, a 17% CAGR over the past 10 years. The combination of organic and inorganic strategy. But if you could give us maybe just a rough breakout of the broad markets business by end market and how you see this segment growing within your overall corporate target of 10% to 15% sort of annualized growth? Okay. That's a good question. There's a lot to unpack there. But I would say it's going to be over $2 billion -- it was over $2 billion in FY '22. Again, that was 36% or 37%. It's -- given the Android headwinds that we have in 2023, it's going to absolutely outpace our mobile growth and that's going to -- I think that's going to continue to happen into FY '24 and '25 just because of the EV growth and the power isolation traction and the timing traction we have in that space. The data center, we've always wanted to index to the data center and the cloud applications because we're at the endpoints. We're collecting and producing a lot of data with the smartphones. And we know it's all going back up to the cloud, being washed over with algorithms and sent it right back down. So we think that space is going to continue to grow for us. And then just general IoT, the uptake, we're seeing more 5G cellular engines everywhere in smartphones. A growth vector this year that we didn't expect was fixed wireless access, Verizon, AT&T, Comcast, they're all producing products that use 5G cellular engines as backhauls of copper or fiber optic. We're seeing uptick in attach rates in iPads or other tablets. The energy grid management is also a growth vector for us. That could be wireless. That could be LoRa. That could be 5G. So if you look at fixed and mobile IoT, cloud, auto, that's what's going to be driving our growth, and that's where we're putting our money. So I believe you mentioned this, the team finished fiscal '22 with automotive revenues annualizing at $200 million plus. That's pretty significant growth. Now you augmented a growing auto connectivity business with the Silicon Labs I&A acquisition in 2021, and you've significantly expanded your auto content opportunity, especially around electrification, right? EV, the team has strong momentum, as you mentioned, power, isolation, both for DC/DC conversion, your gate driver portfolio for the main traction inverter and EV. Take us through the auto portfolio. Let's do a deep dive in the auto portfolio. And you mentioned some of the customer logos. But mention some of the customer logos and more importantly, how do you see the growth of this segment over the next few years? I mean the first thing that comes to my mind, given your isolation and electrification products is if you look at third-party estimates out there, I mean EV growth is, production is targeted to grow like 30% CAGR or something over the next few years. Yes, that's right. So it's a little bit daunting to consider how fast that business is growing really. And we're strapped on to that number one -- who I consider as the number one EV maker in the world. We've partnered with them early, and we're hanging on because they're growing quickly, not just in units but also in content. And if you include BYD and Volkswagen and Toyota, a lot of these customers with which we have direct relationships with a lot, we benefit from having a historical strong relationship in 5G. I think given the digital isolation portfolio that we have, the technology that we inherited or that we bought from Silicon Labs is differentiated, it's not the same as what TI or ADI does. They're incredible competitors in this space. So I'm not here trying to say that we're better or worse, but it's differentiated. It's a different approach. It seems to be resonating with these customers. And what we're really focused on right now is the mindset that we entered this acquisition with, which was, we were impressed with the technology. We were impressed with the list of global leading brands, and we wanted to put scale behind it. And we're doing our best to do that. It's not happening as fast as we'd like it to happen. We were caught in the middle of a global chip shortage, as everybody knows. But I think it's going to be a matter of continuing to invest, continue to inspire this mindset down in Texas of taking risks of doing things in a different unique way and then putting the muscle and the resources behind it that we know how to do it well. So your broad markets connectivity leadership has been a strong driver, cellular, WiFi, other connectivity technology is Bluetooth, GPS, LoRa, ZigBee, it sounds like you guys have some content with LEO, those low earth orbit satellite constellations. Where are the biggest opportunities for connectivity portfolio again within broad markets? Is it smart home? Is it smart factory? Is it smart car? I mean, what are the biggest opportunities for connectivity? Okay. Well, I would say right now, what's facing us in the next 6 to 12 months is the upgrade cycle from WiFi 6 to 6E to 7. There's just twice as much bandwidth, which requires more content. And it's more complex because you have coexistent challenges now that you didn't have before. And WiFi impacts everything. It impacts the connected home. It impacts office, enterprise, industrial applications. So that's a very broad-based growth vector for us. But we're also pushing the limits on Bluetooth. People want broader coverage. They want lower energy. We're seeing no slowdown in precision demand for GPS, L1 and L5. We're seeing uptake of new technologies like LoRa by leading brands around the world. And the only -- so I would say GPS and wireless and Bluetooth broad-based adoption, uptake rates, all expected -- and we're seeing updated adoption for 5G cellular engines as well. The disappointing thing about 5G as everybody understands, I'm sure, is that we just don't have real core 5G networks in place yet. Once we do have core 5G networks in place, you'll see a strong uplift in our timing portfolio. Again, our NetSync and our AccuTime, which is really going to be required to make those low latency, ultra-reliable massive machine-type communications, those applications possible. And you'll also see a lot more demand for our 5G core engine technology as well. And so it's going to happen this year, we're getting orders. We have backlog, it's not as fast as we'd like it to be. So I'm not sure we're going to have -- I think the best is yet to come for 5G in broad market applications. You mentioned the WiFi upgrade. We're going through the WiFi 6E upgrade cycle now, which is pretty big. WiFi 7 is the next big inflection. Obviously, the Skyworks team has always had a very, very strong partnership with Broadcom, who typically tends to drive these WiFi transitions. What is the timing of the move to WiFi 7? So we're in the midst of WiFi 6E right now, which is great for broad market applications because you do require new BAW filter technology, more amplification, low-noise amplifiers as well. We think WiFi 7 in broad market applications will begin to launch at the end of this calendar year. And you mentioned Broadcom as a key partner, it's a big driver of the business that we've always had with WiFi. It always gives us a leg up in the transition timeframe, which is important. And the relationship is as strong as ever. In fact, I'd say it's stronger than it's ever has been. We just announced a press release a few weeks ago a collaboration with Broadcom announcing a new product line from scribers called Sky ICE, incredibly low power consumption. And it's the first time really ever the Broadcom at Skyworks have collaborated, not just on the hardware side, but on software side well, able to deliver a 30% reduction in current consumption for the new routers that you'll see coming out enabling service providers like Comcast to really make the industrial idea a lot smaller, a lot more attractive. And we're going to continue that relationship, that collaboration moving forward into WiFi 7 as well. In terms of timing for WiFi 7, we'll see it in broad at the end of this year. I think we should really have to look forward to see broader-based adoption and for the units to really take off is keep an eye towards when the leading smartphone manufacturers start to adopt that. There's a lot of debate about when that's going to happen. I would say we're not that far away. I'd say we're not that far away. Perfect. Okay. Any questions from the audience? So maybe turning to your mobile business. Near to midterm, the team called out weakness in core mobile markets with your mobile business expected to decline about 9%, 10% sequentially, unpacking your guidance, driven primarily by weakness and subsequent inventory correction in the Android market, China market and weakness at Samsung. You're shipping below consumption here. How long does it take for your Android handset customers to clear inventories and drive a profile for Skyworks where you and your customers are shipping to end market consumption. Yes. Well, how extremely frustrating that experience was, right? December -- it was December of 2021, where we began to be concerned looking at inventory levels. We started to correct in March. We hit the brakes hard in June, didn't ship almost anything in September and didn't -- and we'll tell you about December, but the trend really hasn't changed. I -- and let me just preface the next few comments on, it's not all Android. There's a new Android customer here in North America that we're partnering with. We're having great year-over-year sales with. It's really concentrated in our top Asia partners really. And it started in China, it's now impacting Samsung as well. If it weren't for bad behavior on the industry, right, not us or anybody specifically, but everybody fueled that inventory over drive hang. And we seem to do it every -- we seem to have these boom and bust cycles. I really did think it was going to be over by this December quarter. But I'm starting to think it may last into March, possibly even June. The amount of inventory that was -- that’s still in the channel regardless of who it is, we know it's there, and it's going to take some time to work through. But I think we've moved on from that and we've now for a couple of quarters have just accepted the reality, and we're focusing all of our time on new process technology, new optimizations, new iterations across gallium arsenide, across our TC-SAW filter line, our BAW line. We're trying to make our packages smaller and higher performance. In Mexico, we're focused on NPI velocity and ultimately capturing key design wins for these next generation of 5G phones that you'll see from Samsung, from OPPO, from Vivo from Xiaomi, it's just a matter of time before that picks up again. And again, we're focusing on our design win footprint at this point, not so much prognosticating because I just can't tell at this point. Yes. So that's a good segue into my next question, which is on the other side of this, right, obviously, you've taken down your China exposure to near zero, which is -- and as you mentioned, you guys were way more proactive in seeing this back in late '21 and managing down your inventories at Asia/China customers. But coming out of the back end of this, when things do start to recover, how is the design win pipeline? What is the engagement with the OPPO, Vivo, Xiaomis of the world coming out of this. Are you going to be in a much better position content-wise, functionality-wise? Okay. I'm glad you asked that, and I'm stunned that I haven't brought this up earlier in this conversation. Primarily very encouraged and enthusiastic about coming out of this down cycle because we have significantly expanded our technology scope. We are now in a position to extend our success in BAW filter technology from our largest customer to now the other global leading brands. It's too bad, it's -- I guess, I should say, I wish we would have been able to do this sooner. But the reality is everybody knows well, that we had spent many, many years developing BAW filter technology, and we were very conservative with it, very careful. We launched it on the 11, the iPhone 11. We had a more substantial impact on the iPhone 12, the first 5G phone. And you can see from the teardowns, we've increased our position on the 13 and on the 14 as well. We expect that trend to continue. But what that success has done is it's taking a conservative approach upfront because it's not good enough to have good BAW filter technology that you can leverage to make 1 million pieces or 50 million pieces. You have to have BAW filter technology that can hold up to the most aggressive, the most demanding semiconductor cycle of the year, every year, right, producing 100 million devices, 17 or 15, however many we have, 100 million of each of them in four months, and you can't make a mistake. So that drove the careful approach upfront. But then we just could not expand fast enough. We didn't anticipate that the uptake rate at our biggest customer would be as big as it was. So we have been limited on that mid-high band primary path and the mid-high band receive pet and some of the ultra-high band path at the other leading brands. And as everybody knows, that's a large part of the smartphone RF opportunity. We're now ready to do that. And so when we come out of this -- we won't come out of this -- we'll come out of it with a larger TAM, a larger SAM, serviceable available market than we ever had before. And so that's making us feel pretty good. So can you just help us understand of your mobile solution sales? How much of those solutions now integrate one or more Skyworks BAW filters and where you see future opportunities for your BAW technology? I think you already mentioned mid-high band and others in some of your Asia and emerging customer -- other emerging customers, but talk about some of the future opportunities. But more importantly, just curious as to the attach rate that you're seeing currently now with some of your flagship customers. Okay. So let's break down the numbers then. We just finished '22, our fiscal year, right, in September. We did $5.5 billion, $2 billion of it was broad. So there was about I guess, $3.5 billion of mobile business in our fiscal year 2022. $1.5 billion of that required BAW filter technology, and it was all concentrated at our largest customer. We need BAW for everybody else. We need it for Samsung, we'd like to sell it to OPPO, Vivo, Xiaomi. But we're also seeing it in broad market applications in broad, as you move to WiFi 6E, you need BAW in cell phones, when you move to 7, you'll need BAW. In the automotive press release that we just announced with MediaTek, there is BAW so you need it in cars as well. You need it almost everywhere. And for us, industrial applications is where we are seeing advanced robotic manufacturing in areas that are deploying core 5G networks. So we need it everywhere, and it's just a matter of scaling it out. And like I said, we've reached the tipping point, we can now extend it, and we're excited about it. So you talked a lot about your larger customers, North American and Korean customers. How should we think about the forward content opportunities in the ultra-premium end of the market for Skyworks? How should we think about the opportunity in the ultra high-performance space? Okay. So that's getting more complex, right? Like I said before, we're now dealing with satellite communications. You're going to see attach rates pick up at other OEMs. You're going to see other satellite providers getting in the game. WiFi 7 is going to be disruptive in smartphones, you have over 1 gigahertz of new bandwidth right next to the ultra-high-band 5G bands. That's going to increase complexity. And so what we're focusing on now, and we can't do it fast enough, but we're iterating every process technology that we have. We're optimizing and iterating our HBT GaAs different types of applications for WiFi for 5G and within bands, it changes as well. We're iterating and we're optimizing our TC-SAW technology. We're trying to make it better, smaller, consume less energy, put multiple die on the same -- or multiple filters and duplexers on the same die. We're doing the same thing with BAW, we're working with our upstream partners as fast as we can to iterate and optimize SOI and CMOS. And then the investments in Mexicali, I think, are often overlooked and underestimated. We take all of those different processes and materials and technologies and put them inside one package right next to one another, and we solve the coexistence problems necessary to meet specs for the most demanding, the most discerning customer in the industry. And again, we do it at very high velocity, 100 million sets in three or four months. We are continuing to do that as fast as we possibly can, and the focus is on energy consumption and space because we are seeing such a compelling uptake in things like 5G applications for smart watches. We expect to see significant movement in the next 3 to 4 years in AR and VR, and there's going to be a need for a very small RF, 5G front end somewhere in a set of glasses or a set of VR goggles. So I think the trends are coming very fast, and we're doing everything we can to prepare in advance be in position to meet those. On the financial front, even with your guide down in the December quarter, your gross margins are holding up extremely well, right, and are expected to hold around that sort of 50%, 51% range even through a potentially weaker first half of this year. I know the team's level loading strategy helps smooth out the internal utilize throughout the year. But what are some of the other puts and takes to keep gross margins potentially steady even in a weak top line growth profile year? So the level loading is important, and that's an operations issue. I think we do that quite well, supported by great data analytics and customer relationships. But what's most critical, what central to the strategy is we need to capitalize on the complexity trends on the demand for integration and smaller packaging. If we can optimize everything, iterate everything, pull it all together, deliver these smaller packages in a way that enables our end customer to differentiate their product in a way that drives compelling value, then we're going to continue to win. We're going to continue to do well and so with our customers. What we just can't do with stand still. We are not interested in doing -- we just -- we're not good at doing last year's technology. We need to stay at the front end and continue to drive the envelope in terms of performance. And it's a mindset that's cultural. We have confidence and that's the way to keep the margins up.
EarningCall_1416
Good day and thank you for standing by, and welcome to Scholastic Reports Q2 Fiscal Year 2023 Results Conference Call. At this time, all participants are in a listen-only mode. Please be advised that today’s conference is being recorded. Welcome, everyone, to Scholastic’s fiscal 2023 second quarter earnings call. Today on the call, I am joined by Peter Warwick, our President and Chief Executive Officer; and Ken Cleary, our Chief Financial Officer. As usual, we posted the company investor presentation on our IR website at investor.scholastic.com, which you may download now if you have not already done so. We would like to point out that certain statements made today will be forward-looking. These forward-looking statements, by their nature, are subject to various risks and uncertainties and actual results may differ materially from those currently anticipated. In addition, we will be discussing some non-GAAP financial measures as defined in Regulation G. The reconciliation of those measures to the most directly comparable GAAP measures can be found in the company’s earnings release and accompanying financial tables filed this afternoon on a Form 8-K. This earnings release has also been posted to our Investor Relations website. We encourage you to review the disclaimers in the release and investor presentation and to review the risk factors disclosed in the company’s annual and quarterly reports filed with the SEC. Thank you, Jeff, and good afternoon, everyone, and thanks for joining us. Scholastic delivered strong revenue growth and higher earnings in our second quarter of fiscal 2023, as we successfully navigated continued market and cost headwinds during the important back-to-school season. The company’s sustained momentum reflected three things; first, the strength of Scholastic’s brand, unique channels, children’s content and educational products; second, the improved operating efficiencies we have achieved over the past three years; and third, our continued investments in long-term growth opportunities. Last quarter, we continued taking steps to deploy capital for long-term growth and shareholder value. We completed our acquisition of Learning Ovations and made progress integrating its product, technology and team. We also accelerated capital returns to shareholders, executing a modified Dutch Auction tender offer and expanding our open market share repurchase authorization as announced this afternoon. We expect this momentum to continue in the second half of fiscal 2023, especially in our seasonally important fourth quarter and have affirmed our guidance for the year, as I will discuss further in a moment. These are very encouraging results, but I am especially proud of Scholastic’s nearly 7,000 employees who continue to perform at such a high level without losing focus on Scholastic’s important mission and enormous long-term opportunity, supporting the growth of children through literacy and the power of stories. This afternoon, I’d like to review our momentum and outlook across our business. Ken will then walk through our financial results and expectations for fiscal 2023. But first, a few words on the current business environment. As it’s been widely reported, consumer confidence in the U.S. has continued to decline this fall, even more so in the U.K. and Canada, two of our largest international markets. This has impacted the retail bookselling environment, which has been softer this calendar year compared to a strong year in 2021. In U.S. schools and school districts, federal and state funding remains at historically high levels. But as we discussed last quarter, short staffing and the need to digest last year’s product purchases have lengthened selling cycles across the industry and has shifted some expected sales into our fiscal fourth quarter. On the cost side, paper, manufacturing and shipping costs remain at high levels. In this slide, I believe Scholastic’s quarter two gains are even more impressive, indicative of our company’s strengths and competitive advantages and I am also optimistic about the near- and long-term market outlook. In the short-term, there are encouraging signs of a rebound in consumer confidence as, for example, gas prices have fallen. Also, the impact of higher input costs is now fully reflected in cost of product and our P&L after first flowing through inventories, reducing that year-over-year headwind. There are signs of cost improving in some areas, including reduced lead times for inventory purchases and lower transportation costs. In the long-term, we see families and kids need and demand for literacy and stories to promote happiness, knowledge and confidence only growing in the future, as the world becomes even more complex and competitive. There’s also a strong consensus that pandemic-related declines in student’s reading skills, which were already distressingly low in the U.S., demand sustained long-term investments in new outcomes based approaches to teaching literacy, especially in the earlier grades and this is exactly where Scholastic’s brand, experience, teacher relationships and sales channels are strongest and where we are targeting investments to scale our Education Solutions business. So turning to our quarter two results. Last quarter’s gains were led by strong results in the Children’s Books segment. Revenues rose 19%, reflecting robust sales in Scholastic’s unique school-based Book Fairs and Book Club channels and the benefit of our bestselling children’s publishing. Operating income increased 33%, driven by higher sales strong operating leverage and improved efficiencies. The Scholastic Book Fairs team achieved a record fall with revenues up 37%. Share counts rose to 85% of pre-pandemic levels as we planned compared to 70% a year ago and we experienced even stronger revenue per fair than last year. In Book Fairs, operating leverage on higher sales, as well as investments over the past three years to optimize warehouse branches, enhance processes and improve overall marketing and sales efforts, all these contributed to higher segment profitability. In our Trade channel, revenues held near last year’s high levels. Bestselling, publishing and multiple new releases mostly overcame the impact of a softer retail market. They also benefited sales in our Other Channels and in our International and Export businesses. Scholastic’s Graphix imprint continues to dominate the young adult graphics novels segment, which it effectively created. In November, Scholastic titles held 18 of the top 20 bestsellers on NPD BookScan Young Adult Graphic Novel List. Dav Pilkey’s newly released Cat Kid Comic Club #4, held a number one position and in fact was the bestselling title children’s and adult categories in its first week of release, also performing well in school channels. Scholastic also continues to benefit from a tremendously strong backlist of children’s and young adult books and series, including recent classics like Harry Potter, of course. Last quarter, orders for the new illustrated edition of Harry Potter and the Order of the Phoenix were strong, and we are excited for the upcoming 25th anniversary of the series next September. J.K. Rowling’s Christmas Pig also sold very strongly in its second season on its way to becoming an evergreen holiday classic. We continue to successfully develop our IP for the screen too, Stillwater, the animated series on Apple TV+, which celebrates mindfulness and is based on Jon Muth’s titles, just this past weekend received its second Emmy Award. We are eager to see the positive response to Eva the Owlet in quarter three, the live action Goosebumps series later on. Book Clubs revenues rose 11% last quarter relative to the prior year quarter when the business experienced significant labor and systems issues that delayed revenues into the third quarter of fiscal 2022. Book Clubs has experienced higher revenue per event, but lower than forecast teacher participation so far this school year, in part reflecting the enormous and increasing demands on teacher’s time. We are focused on the activation and reactivation of teacher sponsors and increased student and family participation. At the same time, Book Clubs continue to provide a critical connection between Scholastic and teachers, families and kids, which benefits the entire company. Book Club flyers and the Club’s online presence are key channels that build awareness of new book titles, reinvigorate the backlist, feed potential purchases to our website and reinforce the Scholastic brand. Now moving to Education Solutions. Quarter two sales to schools, districts and states held steady at last year’s record levels, as we continue investing in the division’s long-term growth opportunity. As mentioned earlier, longer selling cycles for educational products are having an impact on timing. This dynamic means that some of the sales that in prior years, we might have expected in the first and second quarters we now expect to come through in the second half and in the fourth quarter, in particular. As planned, continued strategic investments in long-term go-to-market capabilities for this segment impacted operating income. We are progressing well with the integration of the recently acquired A2i Literacy Assessment, an instruction system and Learning Ovations development, professional learning and research teams are now integral parts of the Education Solutions division. Increased employee-related costs will assist in the continued development of the company’s comprehensive digital literacy platform. Next, looking at our International segment. In local currency, revenues increased 8%, but declined overall due to the strengthening of the U.S. dollar. Higher local revenues were primarily driven by continued recovery of Book Fairs and the success of the company’s bestselling series titles in trade. However, revenues are also impacted by more challenging market conditions in Canada and the UK than in the U.S. Segment operating income decreased $2 million, reflecting higher inflationary costs related to freight, paper, fuel and labor in major markets, and economic conditions in Canada and the UK. This was partially offset by improved margins in Asia and export, following the company’s exit from the low margin direct-to-consumer business in Asia, which generated losses in the prior period. As I previously discussed, we are confident in our ability to continue navigating the current business environment and are affirming our fiscal 2023 guidance for adjusted EBITDA of $195 million to $205 million based on our momentum in the first half of the year and expectations for a strong fourth quarter, following a seasonally smaller third quarter. When looking ahead at the second half of fiscal 2023 and our plan to achieve this goal, it’s important to consider Scholastic’s business seasonality, which now more closely resembles what we routinely experienced before the pandemic. Traditionally, the second and fourth fiscal quarters have been our largest, most profitable periods, with losses recorded in the smaller first and third quarters, when schools are on summer or winter holidays. I’d also point out that earnings and adjusted EBITDA typically being highest in the second half of the year. We are seeing a return to the seasonality in fiscal 2023. We and we expect the final quarter of the year, I have to say March, April and May to be driven by the strength in our Book Fairs and strong sales in Education Solutions. Finally, I’d like to address Scholastic’s continued progress towards its capital allocation strategy and priorities. As I said, Scholastic’s significant margin improvements over the past three years and our strong free cash flow outlook create new opportunities to deploy capital for strategic growth. At the same time, they enable us to maintain a strong balance sheet and return excess capital to shareholders. Last quarter, the company returned over $32.9 million to shareholders through an increased dividend, open market repurchases and the modified Dutch Auction tender offer. Today, we also announced that our Board has significantly expanded the company’s open market repurchase program with an increased authorization of $48.8 million to make $75 million currently available for this purpose. In order to deploy this authorization, we will take maximum advantage of opportunities under our open market repurchase program. As we look ahead, we will continue to pursue opportunities to deploy capital in three key areas, consistent with our allocation priorities. First, we will continue to invest in building or acquiring strategic products and capabilities that leverage our current brand channels and capabilities. For example, investments to build capacity and efficiencies in our Book Fairs and Jefferson City distribution networks. We will also continue to explore larger more transformative investments to build or acquire new platforms as we are doing with our literacy platform. Second, will continue to leverage the strength of our balance sheet to manage risk and support our operations as we have done by funding early inventory purchases or payment discounts to offset supply chain difficulties and higher costs. We will also continue to review opportunities to optimize our capital structure, while protecting our balance sheet strength. And third, we are committed to continuing to return excess capital to shareholders. In addition to our dividend, which we raised this summer and expanded open market repurchases, we will continue to explore additional return mechanisms as we undertake to build market liquidity in our stock to facilitate future repurchases. Thank you, Peter, and good afternoon. Today, I will refer to our adjusted results for the second quarter, excluding one-time items in the prior year period unless otherwise indicated. Note we recorded no one-time items in the second quarter. Please refer to our press release tables and SEC filings for a complete discussion of one-time items. As Peter discussed, company performance during the critical back-to-school second quarter of our fiscal year was excellent, driven by strong performance in our Children’s Book Publishing and Distribution segment, which benefited from our improved Book Fair operations in a more normalized school environment. On the operations side, our plan to order inventory well in advance of the season, given the long lead times in our supply chain has been successful, as product availability across the company has driven down backlog, improved customer satisfaction and helped to reduce operating costs. Across the company, we are managing operating and headcount costs to below pre-pandemic levels while still investing in growth and ETFs. We are experiencing substantial cost increases for paper, printing and transportation that are impacting our gross margins, but are seeing the inflationary pressures starting to abate. In short, we continued our strong start to our fiscal year in the important second quarter and are optimistic about the future. We are therefore affirming our adjusted EBITDA guidance of $195 million to $205 million for fiscal 2023. Turning to our consolidated financial results, revenues grew 12% to $587.9 million, operating income in the quarter was up 19% to $100.1 million, net income was $75.3 million, compared to $64.4 million last year and adjusted EBITDA rose 14% to $122.3 million, compared to the second quarter last year. Earnings per diluted share was $2.12, compared to earnings per diluted share of $1.80 last year. For the six-month period, revenue was $850.8 million, compared to $784 million last year, and operating income was $42 million, compared to $48.1 million last year. Six months adjusted EBITDA is $86.7 million, compared to $94.5 million last year. Net cash provided by operating activities for the six-month period was $21.3 million, compared to $141.6 million last year. Free cash used for the six-month period was $13.8 million, compared to free cash flow of $124.5 million last year. As a result of our successful strategy to acquire inventory earlier this year in anticipation of increased sales and longer lead times, as well as due to higher cost of product, inventory purchases year-to-date have increased $140.2 million relative to last year’s suppressed levels, contributing to the increase in cash utilized for this fiscal year. We estimate that approximately a third of this year-over-year increase reflects the timing of inventory purchases within the fiscal year. We are starting to see lead times for inventory purchases start to decrease and are modifying our buying patents to better match these shorter lead times. Additionally, last year’s cash flow benefited from a $63.1 million federal tax refund. At the end of the quarter, cash and cash equivalents exceeded total debt by $256.3 million, compared to $286.4 million at the end of the second fiscal quarter a year ago. Our strong balance sheet has allowed us to proactively manage working capital through the supply chain crisis by strengthening vendor relationships and negotiating volume rebates at early pay discounts, while also allowing us to invest in content with key bestselling authors. Capital expenditures and capitalized prepublication costs for the six-month period were $35.1 million, compared to $27.5 million last year. We expect CapEx and prepub spend to exceed last year, as we invest in our Education Solutions business and distribution operations. In the current fiscal year, we returned capital for our tender offer for our shares and open market repurchases. Through today, we have reacquired 724,000 shares, returning $31.1 million to our shareholders in the current fiscal year. While our tender offer was undersubscribed, we will continue to pursue open market share repurchases. To this end, our Board of Directors has approved an increase in our current share buyback authorization from $26.2 million to $75 million. Additionally, our Board of Directors has approved a $0.20 per share regular quarterly dividend to be paid in March. The company is committed to continuously monitoring and improving our capital allocation, focusing on long-term growth operational efficiency and returning excess capital to shareholders. Now turning to our segment results. In Children’s Book Publishing and Distribution, revenues for the second quarter of $418.3 million exceeded the prior year’s revenues of $352.5 million. Operating income increased to $113.2 million, compared to $85.2 million in the prior year period. Our Book Fairs operations led these impressive results. Book Fairs’ revenues increased to $240.8 million from $176.2 million in the prior fiscal quarter. Fair count is on track to rise about 85% of pre-pandemic levels from 70% last year. Coming out of the pandemic, our operations are greatly improved and demand at event based activities such as our in-person Book Fairs is strong. Our Book Fairs team has worked to simplify and amplify our fair offerings through improved product assortment, marketing and fair experiences and by facilitating better family and student engagement, including through strategies to expand equity of access. Accordingly, revenue per fair, a key efficiency metric grew substantially over last year. Higher revenue per fair results in improved margins and profitability as it does not entail significant increases in operating costs. Book Clubs revenues of $57.6 million were higher than the reported revenues of $51.9 million in the prior period. As previously mentioned, the prior period was hampered by system implementation issues, which showed higher distribution costs and a backlog of customer orders last year of approximately $20 million as of November 30, 2021. These orders were delivered in the third quarter of last fiscal year. These systems and operational problems have been fixed, and as a result, our distribution costs have improved dramatically and we did not have order backlog at the end of this Q2. Trade division posted strong results against a good prior year quarter, with revenues of $119.9 million, compared to $124.4 million last year. In the prior fiscal quarter, we released J.K. Rowling’s The Christmas Pig, which drove the higher revenues in the prior period. As previously mentioned, product availability was strong this year, but product costs were substantially higher than the prior year rising about 15%. Our Trade Publishing group is the key content provider for the entire company and our industry leading editorial staff continues to develop and maintain relationships with key authors, illustrators and agents in the children’s publishing world. Content produced by the trade group also fuels our growing media footprint, with key productions such as Eva the Owlet, which was announced earlier this year. Education Solutions revenues of $80 million were on par with the prior year revenues of $79.5 million. Quarterly operating income was $7 million, compared to prior year operating income of $15.6 million. We are currently investing in this division and we have identified substantial growth opportunities. As Peter mentioned, these are exciting times in Education Solutions as we continue to build out our solutions model and product offering. The Learning Ovations acquisition and their proprietary assessment tool A2i are a key focus of this effort. As a result of this increased investment, we are building out staff, increasing development work, increasing sales capabilities, and spending OpEx and CapEx on the integration of A2i. Accordingly, we expect higher costs in this segment for the current year. The integration of A2i is now expected to impact earnings by approximately $3 million in the current year, which was not contemplated in our original plan. Overall, federal and state funding is expected to positively impact this segment through calendar year 2024. The ultimate annual results for Education Solutions are largely dependent upon the fiscal fourth quarter, when schools and districts seasonally spend funding on curriculum and other products for the upcoming year and when summer reading programs kick in. While we have outperformed our expectations in each of the last two fiscal fourth quarters, the volume and timing of sales in this period can have material impacts on the company’s fiscal year results. International segment revenues of $89.6 million trailed the prior period revenues of $92.2 million, with foreign exchange rates driving $10.1 million of the decline due to the strong U.S. dollar. Operating income of $6.7 million was unfavorable to the prior period operating income of $9 million. Australia and New Zealand saw widespread lockdowns in the prior year second quarter but recovered and are now exceeding our expectations for the current fiscal period. While Canada and U.K. operations continued to recover from the pandemic, each of these nations is now being impacted by worsening economic conditions that are driving costs higher and lowering the disposable income of their customers. Much like the U.S., Book Fairs operations and the demand for event-based activities in Canada, Australia, New Zealand and the U.K. are bright fine. Our business in China continued to struggle under COVID restrictions and government regulations around tutoring and foreign content, but recent actions regarding COVID restrictions are encouraging. Unallocated overhead costs of $26.8 million in this year’s second fiscal quarter, but relatively flat to prior year’s second quarter, as we continue to tightly control discretionary spending and are experiencing improved efficiencies at our centralized distribution facility. I am happy to report that we have recently signed a long-term lease agreement for the remaining Broadway facing retail space in our headquarters property at market rates signaling some return to normalcy in the New York City real estate market. We expect the occupancy to commence later this fiscal year. As a result of our performance year-to-date and our current forecast, we are affirming our adjusted EBITDA estimate of $195 million to $205 million. Cost of product is trending modestly higher than our initial expectations as a result of higher freight costs. We are starting to see these costs decline. We continue to show strong discipline on discretionary spending. In our school-based channels, Book Fairs’ results, notably revenue per fair have exceeded our expectations, were partially offset by declines in teachers participating in our Book Clubs programs. We are encouraged by our strong customer engagement and demand for our products, content and solutions, and we are focused on delivering current results, while building on growth opportunities for the future. External economic risks remain, but our businesses have proven to be resilient through economic downturns in the past and we expect any impact to be modest. Thank you, Ken. As both of us have discussed this afternoon, Scholastic performed strongly in the second quarter, as we leaned into our unique strengths and competitive advantages to serve kids, families and schools, while successfully navigating a more complex business environment. Based on our current momentum and a positive outlook, including for a strong fourth quarter in the near-term and growing long-term demand for our literacy in stories, we are optimistic about our future growth and achieving our full 2023 goals. In closing, I want to again thank every educator, family and partner that’s helping raise up the students in their community, as well as our employees who are working tirelessly to support you. I also want to thank our shareholders for their continued support and I wish everyone a happy holiday season. Thank you, Peter. As a reminder, we invite questions to be directed to our IR e-mail, investor_relations@scholastic.com. We appreciate your time and continued support.
EarningCall_1417
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, Chris. Good morning everyone, and thank you for joining GATX's fourth quarter and 2022 year-end earnings conference call. I'm joined today by Bob Lyons, President and CEO; Tom Ellman, Executive Vice President and CFO; and Paul Titterton, Executive Vice President and President of Rail North America. Please note that some of the information you'll hear during our discussion today will consist of forward-looking statement. Actual results or trends could defer materially from those statements or forecasts. For more information, please refer to the risk factors included in our earnings release and those discussed in GATX's Form 10-K for 2021, and in our other filings with the SEC. GATX assumes no obligation to update or revise any forward-looking statements to reflect subsequent events or circumstances. I'll provide a quick overview of our 2022 fourth quarter and full-year results. And then I'll turn it over to Bob for additional commentary on 2022, as well as our outlook for 2023. After that, we'll open the call up for questions. Earlier today, GATX reported 2022 fourth quarter net income of $48.4 million or $1.36 per diluted share. This compares to 2021 fourth quarter net income of $61 million or $1.69 per diluted share. The 2022 fourth quarter results include a net negative impact from tax adjustments and other items, of $0.18 per diluted share. The 2021 fourth quarter results include a net positive impact from tax adjustments and other items of $0.11 per diluted share. For the full-year 2022, GATX reported net income of $155.9 million or $4.35 per diluted share. This compares to net income of $143.1 million or $3.98 per diluted share in 2021. The 2022 and 2021 full-year results include net negative impact from tax adjustments and other items of $1.72 per diluted share and $1.08 per diluted share, respectively. Details related to tax adjustments and other items can be found on page 13 of our earnings release. As noted in the release, we currently expect 2023 earnings to be in the range of $6.50 to $6.90 per diluted share. Thank you, Shari, and thank you all for joining the call today. I'll provide some brief comments on 2022 performance versus the outlook we had coming into the year, and then try to provide some additional color on the 2023 guidance we gave in this morning's press release. Before jumping in, I want to thank our employees for their continued focus and the effort they've put forth over the past year. Across GATX and all of our businesses, Rail North America, GATX Rail Europe, GATX Rail India, Trifleet, and our engine leasing business and partnership with Rolls-Royce, everyone performed at a very high level. I fully expect we'll carry that momentum into 2023, all with the goal of continuing to generate attractive risk-adjusted returns for our shareholders. So, let's start by looking back first at 2022, and I'll try to do so briefly. We outperformed our initial expectations for two key reasons. One, Rail North America performed better than planned. And two, Portfolio Management did the same. So, let's look a little bit more specifically at each one of those. At Rail North America, in the middle of the year -- in the middle of 2022, we updated our earnings guidance based on strong secondary market activity. That continued in the back-half of the year, so for the full-year we came in higher than planned. We took full advantage of the opportunity to continue to optimize our fleet. Second, the lease rate environment for existing railcars was very favorable. There were a host of factors that led to this. But one of the key things was, is that customers were very focused on retaining holding on to the cars they had in their existing fleet. Therefore, lease rates increased throughout the year and lease revenue came in stronger than planned. Our commercial team did an excellent job. Third, with demand for existing railcars is as high as it was, you end up with a very high renewal success rate, which we indicated in the press release. And when there's less churn in the fleet there are fewer service events, and that has a positive impact on expected maintenance expense. So, in summary, at Rail North America versus the expectations we had coming into the year, we ended up with higher remarketing gains, higher revenue, and [lower net] [Ph] maintenance expense. And that's a very good recipe for a solid year. All of those factors led to Rail North America reporting a substantial increase in segment profit for the year. Within Portfolio Management at our Engine Leasing joint venture, the story is pretty straightforward. We entered the year mired in the pandemic, so our outlook was fairly muted, potentially even negative. But during the course of the year, international air travel recovered. And while it's still well below pre-pandemic levels, the trend was helpful. And that led to Rolls-Royce & Partners Finance, our joint venture, posting higher operating income and having to deal with fewer customer credit issues than we assumed. Those factors drove higher than planned segment profit at Portfolio Management. The performance of those two segments enabled us to overcome lower than expected segment profit at Rail International. While demand was very strong, Rail International had to contend with significant market disruption. In Europe and India, the teams had to deal with the fact that the war in Ukraine led to significant supply chain issues. That led to railcar deliveries in Europe and India been delayed versus our plan. We also had FX rates quite volatile and serving as a headwind. But I would like to note in the face of these challenges, our teams did an outstanding job manning our business day to day. And we are very positive about our prospects internationally. My last comment on 2022 is that invested over $1.2 billion in our core markets. So, despite rising asset prices, we continue to find opportunities to put capital to work at attractive returns. That’s a testament to our team, to our customers, and to the reach we have into the markets in which we participate. Much like railcar renewals, a lot of our investment volume comes in very small lots. It’s a hallmark of what we do at GATX and one that enables us to continue to drive returns. Let’s turn to 2023, as Shari noted we expect EPS to be in the range of $6.50 to $6.90 per diluted share. The midpoint of that range implies another year of double digit EPS growth of the adjusted 2022 results. This would represent another very strong year, especially following the exceptional EPS growth of approximately 20% posted in 2022. So, let’s move on to some of the main drivers for the year ahead. Within Rail North America, we expect another very good year in terms of lease rates. And we are looking at the LPI rate coming in above the 23% we achieved for the full-year of 2022. With the full-year impact of last year’s rate increases flowing into this year and continued increases in rates, we see lease revenue up $30 million to $45 million in the year ahead. We reduced net maintenance expense sequentially in each of the few years. Our team -- our operation’s team has done a truly outstanding job. We are fully maximizing the investments and the efficiency improvements we made in our shop network. However, we will feel some inflationary pressure in 2023. That along with slightly higher service events of railroad repairs leads us to our expectations that net maintenance expense will increase $5 million to $10 million in 2023. As interest rates continue to rise over the course of the last year, it did not have a significant impact in our financial results last year. But, it’s more meaningful in 2023. We are not economists. We don’t play the bottom market. We don’t try to predict where interest rates will go because we’ll certainly be wrong. But, they are going to higher in 2023. And we will feel more of that impact at Rail North America. So, where se sit right now we see total interest expense at Rail North America increasing $15 million to $30 million in the year ahead. We had very, very strong performance in the secondary market. Demand for our assets remains very high. It’s one of the benefits of having a highly diversified portfolio. Is that we can bring assets to market that are of interest to people, other investors regardless of the cycle or interest rates or other macro events. We see that continuing in 2022, and we expect remarketing to come in at the same heightened levels that we saw this past year. So, incorporating these factors, we expect segment profit at North American Rail to increase up to $50 million over 2022 already strong results. At Rail International, we anticipate seeing positive contribution to segment profit growth from both GATX Rail Europe and GATX India. In Europe as I mentioned, demand for wagons is very strong. And we are looking to add 1300 to our fleet in 2023, a level similar to the past year. Hopefully, that turns out to be a cautious expectation, but it’s the correct one to take right now given the supply chain issues that continue in Europe. Importantly, our team in Europe has done an outstanding job of moving lease rates higher. Many of you know rates are stickier in Europe. And moving them up is a challenge. But the team there is delivering. In India, the overall rail market continues to develop. And we are seeing demand --strong demand across every wagon type. Quite frankly, the only issue for us in India right now is whether we can get access to wagons to keep pace with demand. There is a more limited manufacturing base in India. And we are working closely with all of our suppliers to make sure that we have access. We are looking to add over 1800 wagons in the year ahead following the addition of roughly a 1000 in 2022. Based on strong demand internationally, we see segment profit at Rail International increasing $10 million to $15 million in 2023. At Portfolio Management, the biggest driver obviously is our engine leasing activity both at Rolls-Royce and Partners Finance and through our direct investments. As we noted in the press release, we added $150 million worth of engines to our directly owned portfolio in the fourth quarter. We will see the impact of that in 20233 and along with continued contributions from the existing directly owned engines. Also at the joint venture level, we expect to see continued albeit gradual improvement in air travel and a steady improvement in the health of international airlines. As a result, we anticipate continued growth in operating income. And we see overall segment profit at Portfolio Management increasing $10 million to $15 million in 2023. Let me comment on a couple of consolidated line items. We have held the line very well in SG&A in recent years. But unfortunately, inflationary pressures everyone is facing will manifest itself in higher SG&A expense at GATX in the year ahead. We plan to sell some long vacant positions. And we will see higher wages across the board. So, SG&A is forecast to increase approximately $10 million in 2023. But on the flipside, on our other expense line where we recognize our pension expense, we expect to see a decline of $10 million. So, those two SG&A and other expense are expected to largely offset. So with our tax rate coming at a similar level to 2022, the items I just mentioned drive our earnings guidance of $6.50 to $6.90 per share. Looking at investment volume, we again anticipate being north of a billion in 2023 which will be another excellent year. We are going to have to work really hard to find those opportunities just like we did this past year. But with the team we have in place and our global footprint and franchise, I am confident we will be successful in doing so. In the final comment on the guidance and the assumptions that I just outlined, this is one of the most unpredictable environments I have ever dealt with the GATX in my 25 years here. And Paul and Tom, who are also here with me here with today, are also 25-year-people at GATX and they would say the same. The war in Ukraine continues on, interest rates and inflation remain at elevated levels and global supply chain issues while they may not be as acute as they were over the last 12 months, but still an issue. And in North America and Europe, there is economic uncertainty. Will we lapse into a recession? Will we have a soft landing? Will we avoid a recession and so on? I mention this because that adds variability to the assumptions I have outlined. But to be perfectly clear, we feel very good about the position we are in regardless of how these macro factors play out. We will continue to communicate with you clearly on our outlook as the year progresses. On this call, we usually get a question about dividend. So, let me address that now. 2023 marks our 125th anniversary at GATX, something we are extremely proud of. And we are equally as proud of the fact that we have paid dividend now consecutively for 104 years. Few companies can match that mark. We have a regularly scheduled Board meeting this Friday. During which time, the Board will consider the dividend policy going forward. But of course, we understand how important the dividend is to our shareholders. And we value our shareholders, all of you, and especially, those that have been supportive of GATX for decades. So, please look for an announcement on the dividend at the end of the week. And to close before we go on to questions, while I thanked our employees at the onset of the call, I especially want to thank our employees who work on our maintenance network. We have over a thousand people around the globe in our operations network, and they have worked diligently, efficiently, and most importantly, safely straight through the pandemic. They're essential workers and they've been in the shops five or six days a week without fail. And they've been instrumental to our success, and we appreciate all they do. So, thank you. I wanted to start with the question on the trend you're seeing in absolute lease rates. It sounds like you saw another increase sequentially in the fourth quarter. But I was wondering if you could quantify that. And then on the guidance for the LPI to increase more than it did in 2022, what's the underlying assumption for how lease rates trend sequentially from here just on a quarter-to-quarter basis going forward? So, this is Paul speaking. We're going to bifurcate that; I'll take the first part, and Tom will take the second part of your question. So, with respect to absolute rates when we think about sequential improvement from the previous quarter, broadly speaking, for both tank and freight cars, we're seeing sequential improvement in the low teens. That's going to vary by car type, but certainly substantial sequential improvement in lease rates. So then, for the LTI, going forward, we would expect to see a level similar to what we've seen through the course of this year, where, quarter-to-quarter, it varies, but a steady drumbeat of the increasing lease rates. Okay, very helpful. And then, I wanted to ask about RRPF as well, just because the contribution went up pretty significantly in the fourth quarter relative to the third quarter. When you look at that $25 million contribution is there a way to help us understand how much of that is recurring earnings versus remarketing income, and then any thoughts on remarketing expectations specific to RRPF this year? Yes, Justin, so you've been following us a long time and know that that remarketing piece, just like it does in the rail business, can move around quite a bit quarter-to-quarter. So, first of all, just to give you the numbers, for the fourth quarter the operating piece was about $12 million and the remarketing piece was about $13 million. That going forward, Bob mentioned in his opening comments, that we expect increasing contribution on segment profit. And we will see that on both sides. Again, calling the exact timing and magnitude of the remarketing is something that's pretty challenging. Okay, and just, lastly, to clarify on that Portfolio Management guidance for 2023. You talked about a $10 million to $15 million increase in segment profit. I know you've got the incremental contribution from the engine investments that will be wholly owned. So, does that imply that RRPF is relatively flat year-over-year? No, it doesn't. So, that contribution is -- in Portfolio Management is in total, and you would expect to see about somewhere in the order of two-thirds one-third RRPF contribution to [GEL] [Ph] contribution. Good morning and thank you. I had a question on the average term. In the past, when you had -- you've had a strong upcycle, I think they've gotten as high as 70 months, and although that was all the way back in 3Q '07. Can you just give us some color on why the average terms have not moved up as much as one would think in such a strong environment? Yes, Matt, the LPI term for the quarter was about 34 months. And as you noted, it's been in the low-30s all year. Last quarter, we noted that the LPI term is starting to get pretty disconnected from the actual renewal term on a fleet-wide basis. So, last quarter, we gave you that number, we provided that average renewal term for all quarterly renewal activity. And for Q3 that was 49 months. For the fourth quarter, it's 61 months. And for the full-year, it's 52 months. As is the case with all of our statistics, we caution against an over-reliance on any single quarter. So, I would focus much more on that 52-month year-to-date number much more so than the quarterly number I provided. As we look forward, we would expect, directionally, that term to increase in 2023. That's very helpful, Tom. And then as you guys are expecting another strong year of secondary market activity, any insights on where you see your leased fleet -- can you maintain the same size of fleet, I guess, as you take advantage of a very strong secondary market? And will that come using your existing supply agreements in manufacturing because I would imagine it's very challenging to add in the secondary market given how strong it is? Yes, so this is Paul. I'll start, and I think Bob may chime in as well here. But, yes, I mean, at the end of the day, first of all, we're economic animals. So, we are going to invest and divest based on what the economics tell us. And so, we'll buy when we can generate a positive NPV from buying, and we'll sell when we can get a higher price than our hold value. So with that having been said, we are conscious of the benefits of scale in our business, and we believe we can maintain those benefits of scale. And I'll add actually that within in the secondary markets, we are seeing some increasing ability for us to be successful while sticking to our investment discipline. And so, I'm cautiously optimistic that we're going to see more success in the secondary markets. Certainly, the indications are that we're seeing that right now. Yes, Matt, and just to add to Paul's comment too, I've been encouraged actually on both sides of the secondary market as 2022 unfolded. And we're seeing, I think, similar trends here in the early part of 2023 for opportunities to sell, but also to be a little bit more successful in our bidding activity on the buy side. Is this -- are these encouraging signs for potential acquisitions in the secondary market coming from larger fleets, Bob and Paul, or smaller privately held fleets? It can be either. And given our activity and our presence in the market, we see portfolios and we see the -- kind of the offering packages from both, the big and the small sellers. So, it's both. And we've seen, I would say, that the success rate has also been driven by the fact that we've seen some offerings of assets that are of particular interest to GATX in where we have a set view and a very, potentially, unique view on trends over the longer-term. So, we've been able to ferret out some pretty good buying opportunities. Well, at a high level, I'd say yes because, I guess I wake up being pessimistic. But you would think with rising interest rates that that would somehow eventually lead into less activity in the secondary market, but we haven't seen it. And currently, investors, clearly they're still searching for hard assets with a very good yield attached. And we have high-quality assets with high-quality customers on long-term lease, very strong high-quality cash flow. And so, there's still a robust market for those. And I'll just add too. This is Paul speaking again. We've been very successful recently attaching more cash flows to those assets in our portfolio. We've used this strong market to originate attractive leases which will allow us to sort of restock the portfolio of potential sale, going forward. So, that's one of the benefits of a strengthening market like this is it allows you to continue to reload your potential future secondary market offerings. Hi, good morning. Just want to go to that algorithm that you guys have historically provided in terms of rail velocity and cars needed online. I know you were -- sort of come up broken last year, but as we enter this year how are you viewing that? We could be in a situation of, I would think accelerating velocity, potentially, and freight coming down the other side of it. So, would just love your perspective on that, if that's a risk as we look out to the back-half? Thanks. So, I think, with respect to velocity -- this is Paul speaking again. First of all, what I want to say is it's going to be difficult to predict railroad velocity. And so, the railroads obviously are trying to hire, they're trying to improve service right now. We're certainly not in a position to predict on behalf of the railroads what's going to happen with velocity. We do continue to have the view though that there is -- we refer to as freight on the sidelines, freight that is not moving right now that could move in the network if service were improved. So, when we look out and look at the possibility of improved velocity, improved network fluidity, we don't necessarily see that as a downside as we might have seen in the past because we think there's freight that wants to be on rail that will move on to rail once the service is available to take it. So, I would describe us as more optimistic in the face of potentially improving velocity than we might have seen in other cycles. Yes, and Allison, I'll add to that too, Paul's comment there that, as we've said historically, better the higher velocity and more opportunities for the railroads is not something that we fear. We want our customers choosing rail as their mode of choice. And so, we don't want a situation where customers are frustrated because they can't move product by rail and look elsewhere. So, we feel much better and, as Paul said, more optimistic about the fact that if they do improve velocity we know, from talking with customers, there's product there ready to go on rail. Great, that's helpful. And then just a question on boxcars, it seems like there's been a structural decline in terms of amount of scrap, and it's not necessarily surprising, but just want to understand how you view that period, I see you investing, but maybe not at the level of the scrappage rate. Is there a size that maybe you're too large right now, just any thoughts on that fleet overall? No, actually I would say quite the opposite. We've been investing in boxcars, as has the industry. We're not alone in that. We're going through a cycle because there were a huge number of boxcars built in the 1970's, really up through 1981, and those are scrapping out. So, what we're seeing here is the ageing out of the fleet, and then the replacement investment in higher-capacity newer cars to address that. And we think that that replacement demand is attractive. We also think that, to the extent we see more modal shift to rail, particularly ESG-driven modal shift in the future from companies that want to reduce their carbon footprint, the boxcar could really be a beneficiary of that. So, I would say right now, for us, the boxcar portfolio has been a good portfolio for us. And we're hoping and expecting it continues to be a good portfolio for us. Looking at the portfolio, can you talk a little bit about where lease rates are versus your assessments with the long-term average? So, we are finally in a position now where we can report that for most of the portfolio -- for the significant majority of the portfolio, lease rates are now generally over their long-term averages. It's higher for certain car types, lower for other car types. And I would say right now, slightly higher across the board for tank than it is for freight. But in both cases, we are generally at least a bit over our long-term averages across the portfolio. And as you look forward and think about positioning the portfolio, can you talk a little bit high-level about your priority of rate versus term this year, and where you're really pushing harder? So, we are, as we are in all rising rate environments, particularly when rates get above our long-term averages, we are going to work with our customers to incentivize them to choose longer-term leases. And so, this is a playbook that we've repeated in every upcycle. And we're going to continue to push on that now. And lastly, it certainly sounds, at least with tone, that you're more enthusiastic about investing acquisitively in North American rail assets today than you have been in your recent quarter. Can you talk a little bit -- I mean, are we right in that assessment? And regardless of whether we are or not, just anything that you can share about what has changed or where opportunities have resumed in sales, and in how assets are being shaken out of where they were or valuations are being changed? And anything to just give us a little bit of more color on that would be helpful? Thanks. Sure, Bascome. I -- what I would say is, up or down market, GATX is always interested in adding assets to the portfolio, particularly rolling stock. We've done so in up markets, we've done so in down markets. It comes down to us to the attractiveness of the underlying asset and the economic return we can earn. And so, the diversified fleet that we have, there's no asset out there we're not familiar with. And absolutely, we want to continue, that the portfolio is very -- the franchise is very scalable. Platform is very scalable; we want to add asset. But we certainly won't chase them. We'll be -- continue to be very disciplined and selective. But yes, we're always -- there probably isn't many portfolios or many assets that change hands out there that we don't get a look at. And we buy when it makes on -- checks all the right boxes for us. I mean -- but to follow up, it certainly seems like your enthusiasm on something happening sooner rather than later is different than it has been in recent quarters. I'm just trying to understand if there are new assets that have presented themselves or if valuations are coming down broadly across the board, and really just trying to square that with your enthusiasm for continuing to generate quite a bit of remarketing income in the North American rail business? Thanks. Well, I don't think our view has changed materially over the course of the last few quarters, or last few years for that matter. There's often more portfolios talked about than actually come to market. That proves through up or down markets. Would be an interested buyer? Always. Are we going to be extremely disciplined? Always. I think the earlier -- the comment earlier on this call really referred to smaller opportunities that we've seen, one-off asset-type acquisitions that we've been able to execute because we like a particular asset. But as far as bigger portfolios are concerned, I don't really have any other comment to add on that. Would we be interested? Of course, but have no insight or thought on anything taking place in the market. First question would just be on some of the market dynamic, so, you talked about, I think, sequential low double-digit lease rates in tank and freight which would -- have been acceleration from my guess, the 5% or less last quarter. So, what's going on to drive that acceleration from your vantage point? So, it's really more of the same phenomenon we've talked about in recent calls, which is to say you have an existing railcar market that is relatively tight, and that's been driven by a fair bit of scrappage. It's been driven by relatively low velocity on the part of the railroads. And it's been driven by the fact that, thanks to high new car prices and labor availability, the new car production that we're seeing is not consistent with past upswings in the market. So, you have less new capacity coming in, you've had older capacity going out, and you've had relatively low velocity, coupled with what we think is a continued relatively robust underlying demand to move freight by rail. So, it's really all of those things that have created tightness in the fleet and that have allowed us to increase prices. Got you, all right. So, the new car production constraints are maybe not something that were as high like before, but a part of the equation, I guess? Yes, that is correct. I mean, if you look back to the crude boom, you had an industry that produced new cars at a rate of up to 80,000 a year. And at current production levels, the industry is going to be nowhere near that level. So, that's one of the key differences in this market. Okay, that's helpful. And then the scrappage rate, I guess, at least on your book, so about 500 cars per quarter. That's still a healthy scrappage rate. And I assume it's reflective of what's going on industry-wide. Is that sort of a reasonable run rate going forward or are going to go below normal scrappage given how many cars were scrapped in 2021? Given the size of our fleet, Justin, that's a pretty reasonable number on a quarterly basis in our annualized -- just based on the eight cars that will be aging out of the fleet naturally, that’s about the right number. Okay. And then just a couple of nuanced questions, what is the marketable security account on your balance sheet the $148.5 million -- or the short-term investment number related to the $148.5 million? Okay. And on the tax rate you mentioned sort of a similar going forward in that 25%-ish range, so, nothing unusual there. Is there anything as it relates to your ability to I guess postpone cash taxes, it gets harder as it accelerated depreciation comes down? Yes, Justin, we don’t anticipate anything materially changing as far as our cash taxes and our ability to utilize our investment. Okay, great. And then lastly, just -- you mentioned the break down the increase in expected segment profit in Portfolio Management between RRPS. And I guess, the non-JV part of the book can you just sort of clarify that? I think I missed that. And then, is this direct investment -- are you seeing more opportunity there, or is this more of a one-off? Yes. So, the direct investment originally was the engines that we purchased a couple of years ago. And then, we added to it this quarter with an additional $150 million of investment. And the combination of those two is what we are referring to with GATX equipment leasing, which is the wholly-owned aircraft engines. And, Justin, we’ll continue to look for opportunities there as well to kind of methodically, systematically add to that portfolio. We like the asset a lot. It’s been a great return, managed by our joint venture partnership. Those are a very good fit for what GATX does well. So, with our partner managing, it’s a good equation. So, yes, we will continue to look for opportunities there. Okay. You said two-thirds of the increase in Portfolio Management profit is likely to come from the JV and one-third outside the JV? I'd like to thank everyone for their participation on the call this morning. Please contact me with any follow-up questions. Thank you.
EarningCall_1418
My name is Chris Pierce. I'm with the Needham research team. It's my pleasure to welcome to ChargePoint CFO, Rex Jackson, Rex, welcome. Why don't we just give us 30 seconds on the company and kind of then we'll get into some fireside Q&A, and we'll take the last 5 to 10 minutes for any investor questions. Sure. So Rex Jackson, CFO of ChargePoint, we are driving the electrification of transportation or mobility across all verticals. We do residential. We do commercial and we do fleet. We are a technology solutions provider. So we don't make money on power. We don't own assets. We don't try to monetize drivers, what we're trying to do is get the network up and properly supported. So we are -- if you look at the size of the company, we did 140 -- 140, 145, 245 this year. If we can hit our guidance, we'll be, but roughly a double. So 480 would be midpoint of guidance. So fast growing, doing a good job I think and sequentially improving our gross margins, doing a good job also in terms of managing our OpEx and trying to turn cash flow positive in ‘24. So I think that's the company. All right. So as investors think about EV adoption rates in the United States, you had 2022, fluctuations in 2023, high-single digits. Is that something that you think about or your customers pay attention to or is that the wrong question? It's about the longer term, the next three to five years as EV adoption kind of takes hold? So I'd say a couple of things. I think one thing I would readily say and we say this all the time that we are completely dependent in a good way or in a bad way on the adoption of EVs or the arrival rates of EVs and that's both in the passenger space, which drives residential and commercial and also in the fleet space where they're trying to get trucks and buses and yard tractors and that sort of thing. So we're very dependent on how that rolls out because if you look at our numbers historically, what you'll see is, we correlate really closely to that data. So we went, well, if there's a way to build a model, we'll build it that way because that's the best external piece of information that we could see. So asking about that question is super important. But I do think we've reached an inflection certainly in terms of the thought process both the passenger vehicle drivers, so individuals like us and in terms of fleet operators, I think people have really turned the corner to go. EV is going to happen. It's the right thing to have happened. The total cost of ownership, the joy of owning the vehicle, if you're a passenger vehicle owner, the cleanliness of it, I like mine because it's fast, it's quiet, all those things coming together are going to lead to an onset of a lot of additional vehicles. The auto OEMs seem have turned the corner. I know if you watch television, you'll see ads all the time about the latest electric vehicle offering from name brand. That's important. Obviously, the governments have now gotten behind everything from incentives to internal combustion engine car, sunset dates, etcetera. So, how things happen and how quickly things come off a production line over the next two, three, four, five quarters. Obviously, that will affect everything, but I think the momentum in terms of the thought process and the commitment of the various players in the ecosystem is uninterrupted. Okay. How should investors think about the moat that you have in terms of being far and away the leader and installed chargers in the U.S. versus your customers out there, that current position you have now. What does that mean for the shift to DC? What does that mean for three to five years from now? I'm just kind of curious how you position in that moat? Sure. So I think obviously we've -- our best mode is intellectual property, right? And the fact that we have multi-years of investment in our software infrastructure. And then obviously, we had a couple of big hardware platform introductions this year, one on the AC side and then our ExpressPlus, which is a modular architecture and you can sort of pick your power as you go up the DC fast charge ramp in terms of total output. So the stuff that we've been doing and now have released, a, it's hard; b, design and reliability and serviceability and functionality are all super important. And I think we understand the software side of it and the importance of the network for everything from the driver experience to the functionality to payments to remote monitoring, remote repair and that sort of thing. I mean, we just we understand that I think better than anyone else. And so -- and then the other good thing is because we've been around for 12 to 15 years, the benefit of thinking this through and then having 12 years of investment in order to build these platforms. So when you say where are we relative to what we currently have, you can sell into the market. We're just far and away. We think in front of other competitors. And then there are a lot of things that people don't think about when they start to look at little head. For example, do I want to go buy it, do I want to go buy a charging station? Do I want to put this in my parking lot? Do I want to put it in my parking structure? Do I want to put it in my house? Do I want to put it in my depot, they don't think about the whole service and support and reliability side of it. So it's one thing to sell something. It's another thing to have it work and be reliable, be visible, be manageable. And I just think, reproducing all the pieces of that, building a channel, building a direct sales force all of those things are hard to do. They're expensive and -- but we're well along and so now our biggest challenge as a company is scaling, whereas other people still in the development release, can I support a kind of mode. Okay. What do you tell investors who worry about, who focus on 70% of the charging market right now being at home charging? Is that too short sighted or kind of how do you kind of push back against that? So the first thing I would say is, you're right. Right? Because it is true. It's and it may even be a little bit higher than that. So the way we look at the market is, first of all, you want to charge your car using the right infrastructure because home chargers are $700, fast chargers can be more than $30,000. So which solution do you choose is based on the dwell time of the vehicle. So where are passenger vehicles? They sit at home or they sit at work or they sit at a retail center or whatever? So you want to charge your car while you're doing something else. And so we think it's absolutely natural and absolutely right that people are going to charge at home. So you leave your house fully charged. You charge it work, you can top it off if you need to and the only time you access the very high power, very expensive. DC infrastructure is when you're on the road going beyond your battery range. So 90% of charges are going to be on some form of AC architecture. And 10% are going to be on DC fast. But we do both, we just think in terms of providing the customer what the customer actually needs it, that's going to be the breakdown. Okay. And you talked about partnerships and the sales channels that you have. Can you talk about your competitive process as you kind of win, charger installs out there, how you kind of retain or kind of new customer adds and customer retention? Yeah. By vertical, we're a B2C company when it comes to selling our residential home charger stuff. So there just needs to look better, be better, and be priced appropriately. From a commercial standpoint, which is both AC and DC and that's whether it's workplace or hotel or whatever, and I'm speaking mostly about North America right now. There's not a lot of head to head competition that happens there. And I think it's because this burgeoning market. You don't have a lot of companies out there. We're the biggest, but we're not the only. And so there's some places where a deal will happen that we never see. I think head to head, we very, very rarely lose when it comes to commercial deals and I think our customer growth, which is extraordinary, shows that. And then on the fleet side, the fleet guys aren't stupid. So what they do is they have -- they almost always run it through procurement, always do an RFP process. And so there's a good bit more competition there. And I think the main reason for that is; A, procurement; and B, they're willing to be the integrator of the solution. So they'll look at saying, okay. Well, I want to do an RFP to 10 people who might supply software and 10 people who might supply hardware and I'll just pick and choose. And what they don't realize is that you don't want to be the integrator. If you want to get the right solution into your application, you're better off to do some do it with someone like us who has a unified stack from software all the way down to hardware. We do really, really well in the fleet RFP space, but that's the one place that I think we do bump into some other players, who only do one thing. Okay. And are you seeing these fleet or commercial customers kind of not necessarily a pause, but kind of a little more thought press into things as the economy, the macro slows down as EV sales can, not necessarily, the pace of growth slows, considering the pace we saw in the last couple of years or would you push back against that? Short answer, I'd say, was no. Because what's been happening thus far is there's enormous amount of RFP activity and essentially what the major players are doing is they're getting ready. And the go signal for the players in the fleet space is vehicles, right? So totally disregarding what's going on in the economic environment. it would be silly, who would do that. So there's always that impact. But frankly, there are so few electric vehicles in the fleet space right now that if and the people who are motivated to get them out of still motivated irrespective of the economic environment. And when they get them out, they will be purchased. I don't think that's going to slowdown a lot, I really don't. Okay. And you talked about, deals might happen, you might not see, you might, you tend to win deals. There's -- as the market leader, does that lead to rational pricing in the space then that something where or are the pricing conversations? It's funny because we don't go head to head versus [Multiple Speakers] Yeah. I mean, we -- our pricing has been fairly consistent over the years and discounting is not great, meaning we don't do a lot of it. We do have the ability to support channel by providing appropriate compensation to partners and distributors. We were able to put in a price increase, in fact, two price increases last year. Taking into account all factors like supply chain issues and inflation. So we've been -- had very resilient pricing and improving ASPs. And so and then because we don't go head to head with a lot of people, honestly, don't know what they're doing. Okay. And just kind of how do you talk, people might be very enthusiastic about the future of DC charging, you guys are the leader in AC. I don't know, is that an advantage or disadvantage? Or do you think DC is sort of you talked about the right charger for the right person and AC serving most people's needs? So is this sort of DC sort of a service can thing that is kind of getting too much type? I'm just curious how you would think about that. Well, it's a -- I like the way you've asked that question. So I think what a lot of people don't think about is the difference in cost between a port of AC and a port of DC. So a port of AC from us call it somewhere around $3,000. Also, you have to spend $3,000 in terms of an electric contractor to put it the stuff in the ground that you need and behind it. And then so that call it six all in. If you'd buy a DC charger, you're north of $30,000. Again, you got to pay the same amount to put it in. So now you're looking at $60,000 to $75,000 of putting in DC. So what we tell customers is absolutely DC is wonderful. Like feeds and speeds wonderful. But you want to put it in where you need it, and then you also -- the other issue, which is when you pay for power, you pay based on the fastest you pulled at the entire month. And then all of your power is fundamentally at that rate. So it's expensive from every angle, right? So what you do is, you put in DC where you really need it and that could be anywhere from corridor charging. So if I'm driving from LA to San Francisco or New York to Boston, and I want to stop in between. Pull off a freeway boom. There's DC. There's some behind the fence applications for, meaning depot type charging where you have big vehicles that come in and out, and in and out, in and out like a UPS. And then, you might have a valet service or something where you just go, hey, I got people coming in parking lot and they're only going to be for 20 minutes. I can give them, give them a jolt. So I think it's absolutely awesome where it's needed. And it's also the thing I think because it's point to point is going to fill in sooner. That's where the government's focused for example. It's like you got to get DC in because we want to end -- the cut this US. We want to knit the country together from a DC perspective. But all of the infill and all of the around town stuff, almost all of that's going to be AC. Can you touch on NEVI then because that will be, if we're talking about every 50 miles DC kind of networked the company on a DC basis, how does ChargePoint play there? And is ChargePoint benefitted or like since you don't want to sell power, you just want to get these charging stations up or how does this kind of how does that all play together? So I would expect it definitely to be a benefit to the company. So there's an analog to NEVI. I don't know if people remember the whole diesel grade thing. Volkswagen got themselves in trouble and there was a settlement and dollars allocated to the states. There's a process by which those dollars get spent on charging infrastructure. And so NEVI is going to go very much the same path. It's going to look like that in the same departments of transportation in the states or going to get that money and administer it. That process has started. We've mapped the country from our perspective in terms of where we think the best sites are, all the routes in all 50 states. So we're ready to go and we have relationships to start banger because the process is you have to win the money based on your ability to obviously have sites and build them out and provide the infrastructure. The money will actually go to the owner because we never own equipment. The money will go to the site host or the person who owns the piece of real estate where the chargers live. And obviously, they'll use that money to buy this stuff from us, so they'll just be your customer. And I see that rolling out to our benefit. Maybe a little bit this year and then it's going to pick up steam next year, but it's a multi-year, it's probably a five year program, I believe. So it's not something we count on it. I view it as a icing on our fundamental cake of the business there we're doing today. So it'll be good for us, but it's not we're not dependent on it. Okay. And on the last earnings call, ChargePoint, you spoke about bookings north of $1 million. What kind of entities are driving these bookings or is that a 100 chargers and above type orders? Like, is it a commercial real estate like, a mall that has multiple properties and multiple states like, who's driving those size orders? It depends, excuse me, it depends on the application. But it would be large returning commercial clients and principally that in fleet, but mostly fleet I would expect. I think we've said this in prior calls, when you think about our business today, it's about 12% to 15% residential, 60% to 70% commercial and the balance of fleet. There's a little bit of other. And we've said, I wouldn't be surprised if fleet is 40% of our business, two or three years from now. Then what that's going to do is because depots are big, that business is going to be very chunky and you're going to get a lot of big deals like that. $1 million in terms of the depot architecture necessary to drive a meaningfully sized depot is going to be way north of a $1 million. And can you talk about the Mercedes-Benz announcement? Like, what would an OEM for the need to build their own charging network, the co-branded -- and how that RFP went considering, you said you don't want to show the bump up against competitors when you go up with these deals, kind of just the genesis of it through what it might look like when it's installed? Sure. So first and foremost, what Mercedes wants to do is sell electric vehicles, right? And they're a premium brand, so they want you to have a premium charging experience. Excuse me, unlike Tesla, not to bash Tesla, it's not a criticism. They don't feel the need to have a closed system. They're willing to have one that is an open system. So yes, if you're an EV driver driving Mercedes, and you're registered as a Mercedes driver, you could get preferential treatment like the ability to reserve it before you get there, preferential pricing, maybe depending on where the installation is benefits or promotions from the site host. It could be a Starbucks, it could be anybody. And so they view this as a way to provide a premium driver experience to their drivers but not have a closed system. So that was their motivation. They're doing it in such a way that it's obviously going to be quarter charging. They're thinking 400-ish sites, I believe, is the number. Yeah. It will all be all DC. Yeah, because think of it as I think we call it like the 30 minute retail economy. Think of it as you're putting power where someone would otherwise be there for 30 minutes anyway. So they're not -- it's not destination charging. You're not sitting there in your computer or watching your car charge. You go there to do something as you're doing a point-to-point trip, right? So it's very much quarter highway fast-charging kind of thing. I don't -- they're not to their credit, and actually I feel this way about asset ownership generally in this space. They're not trying to make money on the drivers by charging a lot of money for the power and the host who actually owns the real estate is going, well, I'd love to have Mercedes. Mercedes branded charger that looks great, sitting in my parking lock because that's good for me. And they're attracting people to my site to come in and buy coffee or sandwiches or whatever else they're going to do. So it's an ecosystem, kind of everybody wins kind of scenario from Mercedes. Okay. You touched on differences between Europe and the United States a little bit. Can you kind of go a little deeper, I think Europe infrastructure versus how you went over there over here. I think you have maybe 30-year (ph) charges there, but less than 20% of revenues. Like what drives that delta if I had that math right? You are right. So Europe hangs out. It's been as low as 7% to 9% a couple of three years ago and then first quarter this year was about 20% and it's been in the mid to high-teens in Q2 and Q3 as well. So when you factor that percentage against how fast we've grown this year, you go, wow, Europe is really waking up for charge point. The challenge that we have in Europe is really -- it's actually two or threefold. So the challenges are, one, we got there late, right? So we only entered -- we started in the United States 15 years ago. In Europe, we only got there in 2018, I think we're there in earnest, and we might have hired our first person in 2017. So getting their light means, there are a lot of other people who were very busy sort of building their companies and doing their thing from an EV infrastructure standpoint. So we don't -- it's hard to enter a new market like this late successfully. So we've really put an enormous amount of energy behind being successful in Europe. That's a problem that's unique to us. Secondly is, everybody knows it's balkanized. It's multiple countries. And so the language challenges, people who want to buy local, they've got a favorite local provider, they think about things differently. It's a challenge for us to go, okay, well, how do we map whether this a fairly monolithic charge point in North America to something that's what you need to be in order to be successful in Europe. I think we made great strides at that. And so if you have a pan-European customer and you can be the pan-European service provider who supports that customer, I think you have a major advantage. But there are a lot of smaller players that we're going to have to sort of jump over and outrun to be successful there. And then they have, and this is also something that's not unique to us. To provide product to Europe, there are a lot of local requirements that you have to satisfy. To be in Germany, it doesn't bother a German supplier because that's all they do. But when you want to be in Germany and you want to be in France and you want to be in the UK, and they have different requirements in each place to have a platform that can actually nimbly do that is really hard, but we released our AC platform for that this -- it was '23 now, mid last year and then our ExpressPlus super high power modular architecture is also available for moving across Europe. So we've solved -- we've very much solved that problem. I feel really good about what's going in Europe. The only other thing I would mention is, there -- because of how that industry started there without us, I don't think the buyers in Europe understand yet the full value of what we do relative to somebody who says, yes, I'll stick that in your parking lot, and then they leave, right. To have a partner who's got the right software, the right support, the right reliability and the other things that we bring to the table, they should be willing to pay for that, but pricing in Europe is challenging. Okay. And then bringing it back to the United States, specifically California. I think one of the California Universities, the State Universities, did that study about chargers out in the field and some of them necessarily weren't working every time so I pulled up to them. I'm not calling out at ChargePoint charges. They picked on a lot of people in the industry. So what do you kind of tell investors kind of when they kind of preference that study? So I'm not going to spend any time digging into how accurate, I think that study was or how diligent it was just because that's not productive. I will say that what that study is dead right on is that that's probably the number one issue for the EV charging industry, which is, if it doesn't work, I mean -- it doesn't do you any good that the driver pulls up, and it doesn't work. So we have an enormous amount of energy behind making sure that we have the most reliable infrastructure in the industry. The challenges there are -- the two big challenges that the hardest to do with our communications, right? Because we don't own the cellular infrastructure. We just have a location and it's got to talk or go through WiFi. And then two is a human interface where if someone breaks a cable retractor, for example, the things lying on the ground being driven over, there's no software way for us to see that other than to go, well, we haven't had a charge on there for a week, we used to have a lot of charges on there. We can see that -- so that's how we know we have a problem. So the company that's got the scale -- first of all, the thought occurs to them and they had the scale, the reliability coming -- when the stuff comes out of the box. And the other thing is necessary to make sure the infrastructure is always up, plus the software in our service and support org, and our partners everywhere who hit the ground running and a number of hours to go fix something. The team that has that is going to win, and I'm not aware of somebody else who actually has that. Sure. So as everybody knows, you hear about supply chain every day. Short answer is, we've been running 4 percentage points to 5 percentage points of lost margin because, in order to provide assurance of supply, which is we've been very clear is our first priority because winning a customer means you're going to grow with that customer. So winning the customers is really vital. So we said, let's just make sure we maintain supply. So filling those gaps when some -- a supplier says, sorry, I had a problem. I don't have any more of this. I sold out or whatever, and you have to buy stuff in the spot market and then put it on an airplane, that drives your costs up. So we've gone from a readily available just-in-time economy to -- we blew up the world's -- we blew up the entire thing and are sort of starting over from a supply chain standpoint. Has hit us 4 percentage points to 5 percentage points per -- in gross margin each quarter this year. And then the whole logistical side of it, where you're using planes, not boats, that's been pretty steady at a couple of points. For us, no, I would never say never, but we did two deals a year before last in Europe, which was we thought the right thing to do. And we've been very pleased with how it's turned out. But as we look at the landscape today and the fact that our portfolio now is fundamentally complete. There's nothing -- there's -- well, there's nothing we need to do. We've grown nicely in terms of people. So don't need technology, don't need people. So the only thing we might be interested in doing is picking up customers, but paying up for that is a hard thing to justify. But I do expect there to be a lot of M&A activity in the space. It just won't be us because there's capital constraints and stuff and people in the space are going to struggle a bit, and I think putting themselves together is going to happen. What are some short-term KPIs for your business that you look at on a daily or monthly basis or are there some industry KPIs that you look at to kind of give you confidence in the longer-term model? You threw in the model thing was because I was going to start with the hottest topic in the company right now is customer experience. And it's everything from how you quote it, how you price it, how you ship it, how you activate it and then how you support it? And so we want to be as perfect at the end, to end as we could be, and we do better that. When you go to the model, obviously, we've been in a situation this year where, of course, I look at bookings, billings, backlog and revenue. That's behaved pretty well this year. So it's not like we have to grind away on that just yet. It remains to be seen what's going to happen in Q4, no idea. But we obviously look at that. I'd say we spend an enormous amount of time on anything affecting gross margin because that's -- it's the first thing most investors ask us about what's your trajectory there? We like your business model, but we got to see that you can be profitable, how do you get there, and what's that life path look like? And then we spend a lot of time trying to be -- trying to grow up when it comes to OpEx. And so that's monitored daily almost from the FP&A group. We have approval processes to be smart about that and make sure that we're putting our dollars where they need to be. I know those sound very fundamental, but those are the big ones. And then the things that flow out of those are the things you would expect in trying to run a successful company. What if investors do you ask you what the trajectory of gross margins, you said they do ask, what -- how do you enter that question? So we were, let's say, the last three quarters, 17%, 19%, 20% and each quarter, we have flagged the fact that there's 6 points to 9 points of stuff, which is not a highly sophisticated financial term, but supply chain, logistics and then we've had been a couple of charges as we've made these big product transitions I mentioned earlier. So what we've said, we were guiding with a range in gross margin more recently. But this quarter, what we did is we said, look, we expect it to sequentially improve. And the only reason I didn't want to put a number on it is because the range is really wide and the reason it's wide is because it depends on what we can both book a new and build and ship and how we chip away at what was a fairly sizable backlog. So the mix component could really bang things around. But I just expect it to get continually better and then I try to give people that thing I started with, which is, we've got several points that just lying on the ground, right? If we can get through the supply chain issues -- logistics, I think, has eased a bit, but if we get through the PPV issues, work better with our CMs. There's just a lot of things we can do, I think, to bring that number up in an intelligent and sequential way, yes, sir. Having in the EV industry because the higher item prices. Are we going to see when you come to your industry you are going to wait for a couple of years before expanding your network to see how [indiscernible] pay out. Is that not an issue for your industry? I'm clearly looking the demand right now for EV [indiscernible] negatively impacting, there is no question? So I mean when it comes to your industry, is that going to play out [indiscernible]? Or are you going to expand your network, not just you [indiscernible] irrespective of how the demand is going to play out [indiscernible]. So I think that -- I'll try to keep my answer short, actually. The -- if you -- I think the auto industry, because of general economic conditions, inflation and all that other good stuff, not just battery prices, everybody would surmise you were going to sell less cars, right? However, EVs within that number, if you draw two graphs -- two lines you go, well, auto is like this, but EV is like that, right? So the percentage of whatever you sell represented by EVs and the actual raw number of EVs being sold per year is going to go up. We genuinely believe that in a meaningful way, notwithstanding prices on batteries. There's incentives from the government that will help to do some offset there. But I think we have a long way to go before people will go, what, I don't really want to get a Ford Lightning. I'm just not that excited about it. There's a lot of people. I want to buy one, right? So like -- we just think there's an enormous amount of momentum there to provide for a very, very strong EV auto industry, even despite some of the pricing issues as a result of which, and for some of the other tailwind factors I mentioned earlier, we just see the preparation of this country in Europe and Canada to build out an EV infrastructure is going to continue innovate. I don't see people going -- and by the way, the automakers who were putting billions to work to become EV ready and get out EVs, they don't have a choice but to keep going, right? What are they going to do, right? They just have no choice. So I think never say nothing in terms of the external impacts, but I think that the underlying structural momentum is pretty strong. But do you look at the industry in a selling way that if you assign the ChargePoint with this many cars, if you look at the demand or how many [indiscernible]? That is precisely how we build our financial model, what you just said. And what we do is we go for every -- and this is -- remember, I mentioned a correlation earlier, that correlation of us to vehicles. If you look at -- if there's 100 vehicles that are hitting the street, you're going to need 15 public chargers essentially. That number has been a little -- historically a little higher in Europe because they've been doing a lot more, let's get ready that get ready. So there have been more chargers and again, public charters. Our -- just to factor that -- to give you a sense, our market share for AC, for example, in the U.S. is north of 70%. So we go, okay, well, there's 15 needed, and we're going to get 70% of those [indiscernible] and that becomes our model. So on residential, there's a one-to-one correlation, and like one car, you need one charger and almost everybody buys one. So it's a rounding error of those who don't. So we factor that based on vehicle arrivals and what we think our share is. And then on fleet, our current estimate is fleets are going to be, until further notice, roughly one to one as well. So a fleet vehicle will need a dedicated charger. And again, that's not always true, but it's going to be a rounding error for the time being until it's not. So that's how we build our financial model, and we think that holds regardless of who you are as a question of what portion of that demand you get, but that's how you figure out demand. So can you discuss what would be the capacity utilization for the next two to three years given what the demand is going to be? On the installed capacity of charging infrastructure? That's going to be all over the map, right? Residential, very high, right? You go home, you charge. Commercial, it probably pretty high, right, because people drive -- when people are going back to work, I know at ChargePoint, and we're not, obviously, the best case for this, but ours are almost always occupied during the day, right? At night, no, of course, because people aren't at work. Very, very high. I think the utilization on corridor charging, which is the DC fast where you pull off a freeway and you charge is going to continue to be quite low, right? That's 10% or 15%, maybe 20% because that's just the nature of that beast, right? It's -- people aren't sitting there all day. And then fleet is going to be based on the nature of the fleet operator. If you're -- if you're a U.S. postal service, you're going to have a one-to-one correlation. They're going to show up at night, charge and leave the next day. Somebody like a UPS, who cycle stuff a lot, you're going to have super high utilization.
EarningCall_1419
Good day, and thank you for standing by. Welcome to the Eagle Bancorp Fourth Quarter and Year End 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference call is being recorded. I would like to turn the conference over to your speaker for today, Charles Levingston, Chief Financial Officer. Please go ahead. Before we begin the presentation, I would like to remind everyone that some of the comments made during this call may be considered forward-looking statements. While our loan growth and performance over this past quarter have been positive, we cannot make any promises about future performance, and it is our policy not to establish with the markets any formal guidance with respect to our earnings. None of the forward-looking statements made during this call should be interpreted as our providing formal guidance. Our Form 10-K for the 2021 fiscal year and current reports on Form 8-K identify certain risk factors that could cause the company's actual results to differ materially from those projected in any forward-looking statements made this morning. Eagle Bancorp does not undertake to update any forward-looking statements as a result of new information or future events or developments, unless required by law. This morning's commentary will include non-GAAP financial information. This earnings release, which is posted in the Investor Relations section of our website and filed with the SEC, contains reconciliations of this information to the most directly comparable GAAP information. Our periodic reports are available from the company online at our website or on the SEC's website. This morning, Susan Riel, the President and CEO of Eagle Bancorp, will start us off with a high-level overview; then, Jan Williams, our Chief Credit Officer, will discuss her thoughts on the local economy, loans, reserves and credit quality matters; then, I'll return to discuss our financials in more detail. At the end, all three of us will be available to take questions. I'm pleased to report that despite facing economic headwinds, such as higher interest rates, inflation and the threat of recession, the bank ended the year with strong results. We were able to navigate these challenging conditions through our consistent focus on delivering value to our customers and effective cost management strategies. In the fourth quarter, we had our best quarter of loan growth for the year and credit quality metrics remained very strong. Loans increased by 4.5% from the prior quarter-end. This was the fifth consecutive quarterly increase. At the same time, NPAs were 8 basis points on assets at quarter-end. And we had a net charge-off of less than $1 million. Credit risk management has been a constant strength since our founding and it will continue to be a focus going forward. Additionally, our commercial lending teams continue to find new business opportunities to replenish our loan pipeline. And in addition to our pipeline, unfunded commitments were $2.6 billion at quarter-end, up $120 million from the prior quarter-end. Part of our success is our ability to understand, underwrite and close on significant commercial projects. With total risk-based capital of 14.99% and equity of more than $1.2 billion, we are uniquely well positioned to take advantage of opportunities in our market. Our clients know that we are more committed to the business community in the Washington D.C. market than larger banks based outside the area. This commitment also extends to the people in the communities in which we operate. We regularly provide much needed financing for affordable housing projects. This past quarter, there were two such projects. In October, we announced financing for a $42 million project with Howard University to bring a mixed-use development to the Shaw neighborhood of Washington D.C. And, in November, we announced financing for a $50 million affordable rent property with 259 units in Reston, Virginia. And to our shareholders, we remain committed to creating value. This past quarter, our Board declared a dividend of $0.45 per share, which equates to an annualized yield of 4.11% based on last night's closing stock price of $43.78 per share. We were also active in stock repurchases, buying back almost 740,000 shares at an average price of $44.82 per share. In aggregate, the total repurchase amount was $33.1 million. We spend a lot of time looking for cracks in the local economy, but our boots on the ground continue to tell us the Washington D.C. market remains one of the most attractive and resilient markets in the country. Even with difficult and volatile economic conditions, local businesses continued to do well and we have not seen a meaningful pullback in overall economic activity. This is illustrated by the unemployment rate in the Washington Metropolitan Statistical Area, which fell to 3.1% in November, and gives us some favorable separation from the nationwide figure of 3.5% in December. Underlying the good unemployment figure is continued spending from the government, government contractors and consumers. There are some areas where we do see some reduction in demand. Post-pandemic, economic activity in the suburban areas continues to outperform the central business district in Downtown D.C. In Washington D.C., this is somewhat offset by a robust tourist industry, but large parts of the federal government continue to work remotely. Private businesses are more of a mixed bag with a push for more in-office work. With that background, we continue to maintain our conservative underwriting standards, which are reflected in our credit quality metrics. As part of this, while our Downtown office properties continue to perform, we are being more proactive in reaching out to commercial clients to better understand the headwinds facing their income-producing properties. Looking at our credit metrics, which remain strong, nonperforming assets, as Susan mentioned, were 8 basis points on assets. This is the lowest ratio of NPAs we've had since 2005. Total NPAs were $8.4 million, down $1.1 million from the prior quarter. This improvement was primarily from nonperforming loans being paid in full or returning to accrual status as a result of sustained payment performance and net charge-offs of $896,000, most of which was from one C&I relationship. With NPAs down, there was also improvement to our coverage ratio of nonperforming loans, which was 1,151%, up from 997% in the prior quarter. And loans 30 to 89 days past due were $2.2 million, down from $14.3 million at the end of the third quarter. The improvement in 30 to 89 days past due was mostly from one loan for $11 million becoming current. For the quarter, we had a negative provision of $464,000, and our ACL to loans at quarter-end was 97 basis points down from 1.04% last year -- last quarter. With regard to the fourth quarter provision reversal, it was largely driven by the improvement in quantitative metrics associated with a decrease in the localization factor relative to the national unemployment forecast. This improvement was only partially offset by the increased risk in Q&E portion of the model from the elevated risk associated with economic and business conditions and higher period-end loan balances. Overall, in terms of credit, we remain cautious and we will continue to apply our strong underwriting skills. Having said that, we see opportunities to continue to add high-quality commercial loans to the portfolio. Our focus remains on adding local commercial income-producing properties and owner-occupied properties, but we also see opportunities for quality C&I loan growth. This was a good quarter for earnings coupled with strong loan growth and strong asset quality metrics. These results were in an unprecedented economic environment that saw aggressive Fed action on rates, continuing inflation pressures and the prospect of an oncoming recession. Fortunately, as Jan mentioned, we operate in a strong market, which has remained resilient and continues to grow. Typically, I'd start with a discussion on changes on the income statement, but the bigger changes this quarter are on the balance sheet, so I'll start there. The items of note are the strong loan growth, a small decrease in deposits and a pickup in short-term borrowings. And I'm very pleased to say we were active throughout the quarter with stock repurchases. On loans, quarter-over-quarter, the loan growth was strong with loans up $331 million or 4.5% for the quarter. But a lot of these loans came on near the end of the quarter as average loans were up by a smaller $97 million. As we manage our liquidity carefully, we drew on some FHLB advances late in the quarter and ended up carrying more cash balances at year-end than we normally would. In terms of deposits, we remained focused on relationship deposits as that is where we see more cost-effective funding and we continue to strive to improve our deposit mix. To this end, our relationship managers are focusing on deposit retention and deposit growth. Now, stock repurchases. This quarter, we repurchased just over 738,000 shares. This was 46% of the 1.6 million shares the Board authorized for 2022 and about 2.3% of the shares outstanding from the beginning of the year. In total, the aggregate purchase price was $33.1 million and the average share price was $44.82 per share. As the 2022 plan terminated at the end of the year, we have a new plan in place for 2023, which authorizes another 1.6 million shares for repurchase. Turning to the income statement. While net interest income improved marginally up $1.7 million, the most notable changes from the prior quarter were its components, interest income and interest expense. Interest income was up $17.6 million on a higher loan rates and higher loan balances. For the quarter, the average yield on loans was 5.7%, up 77 basis points, and average loans were up $96.6 million. Interest expenses were up $15.9 million on higher funding costs. But the impact was a bit muted by a reduction in interest-bearing liabilities. For the quarter, the cost of interest-bearing liabilities was 2.86%, up 111 basis points, while average interest-bearing liabilities were down $218.2 million. While borrowings were up, the majority of the increase in interest expenses were from higher rates paid on deposits. As the Fed moved aggressively to raise rates to combat inflation, we have subsequently raised rates each time. This quarter, our jump-in rates reflect the Fed raise in late September and two more during this quarter. As a result, our cost of interest-bearing deposits were up 107 basis points, as the average effective rate from Fed funds for the quarter was up 145 basis points. While this resulted in a relatively high beta for us, it was only slightly more than our modeling assumptions. And with our low overhead from our limited branch network, our efficiency ratio is still low at just under 43%. This level of efficiency is much better than our peers and represents a significant built in cost advantage we retain even in the rising rate environment. Other items impacting the income statement were the decrease in income tax expense. This reduction was primarily driven by an update in our state apportionment of revenues. This resulted in less taxable income being apportioned to jurisdictions with higher tax rates. While expenses were up on incentive accruals for this quarter, our accrual allocation is generally lower in the first quarter and larger in the last quarter of the year, as we evaluate ongoing performance. On the bottom-line, earnings were $42.2 million, up 13.1% from the prior quarter, and fully diluted EPS was $1.32, up 13.8%. Lastly, equity at quarter-end rose to $1.2 billion, as earnings and higher carrying values on available for sale securities outpaced the reduction from funds returned to shareholders through stock repurchases and the declaration of the dividend. 2022 was a challenging year, but our Eagle team rose to the challenge. The year ended with solid loan growth and strong asset quality metrics. Even when facing economic headwinds, our commercial focus, coupled with the branch-light footprint, continues to be highly efficient and profitable. Additionally, our team understands that it is our strong relationship-first culture with our customers that allows us to provide superior service and to maintain our leadership position in the community. Also, we remain committed to a culture of respect, diversity and inclusion in both the workplace and the communities we serve. Lastly, I would like to thank all of our employees for their hard work all year long and we look forward to an even better year in 2023. Thank you. [Operator Instructions] The first question that we have is coming from Casey Whitman of Pepper -- I'm sorry, Piper Sandler & Company. Go ahead, your line is open. Yes. Maybe we could start just by going back to the office exposure. Maybe can you walk us through just how big that total book is now? And then, it sounded like from your prepared comments that you might be most concerned with the central business district in D.C. So, do you have some numbers around how big that exposure is? And sort of as you are proactively reaching out to borrowers there, are you seeing any signs -- tangible signs of weakness there? Or just sort of walk us through some of the office exposure you guys have. Sure, Casey. We do have a portfolio of income-producing or [bridge] (ph) office properties. It's about $841 million. It's primarily in the suburban markets. But in the central business district itself, we have $166 million, and we have another $88 million in the construction portfolio, which are completed construction projects that are in lease up. Right now, we are concerned because the market has been fairly slow. The good news is there's a fairly big separation in vacancy between Trophy and A properties, and then B and C properties. The B properties have a much higher vacancy rate today than either Trophy or A. So, the construction properties, while we're always concerned about properties that are in lease and haven't reached stabilization, they are at least in an A or Trophy category in D.C. So, the opportunities there are better than if they were B properties. So, some concern and certainly watching as the leasing takes place. I think overall the vacancy rate in D.C. has been about 20%, but again, it's stratified by different properties. We've gone into a situation where we will reach out to everyone who is in that office market and have lenders and/or their team leaders or the chief real estate lender, accompany the lender to meet with the customer to understand what their challenges are, to understand what their rent roll looks like, and when leases are expecting to roll. The CBD is certainly the slowest market and I think that's generally impacting retail and office in the CBD. Fortunately, we don't have a ton of properties there. So, we're not as vulnerable as we could be. But I still think the early outreach and the planning as to how we're going to bridge these periods of time when leases roll has been a really good effort and continues. We don't have any properties, office properties that are non-performing or past due even 30 days at this point. So, we are trying to be as proactive as possible. It does. Thank you. Are there any other concerns, I guess, in the CRE book outside office that we should be thinking about? I think office is the main concern. And, of course, in the event we do hit a recession, there would be perhaps other concerns. Retail normally would be a concern in this environment, but we don't have a ton of retail in our portfolio. And what we have is mostly suburban grocery-anchored shopping centers. We don't have any big shopping malls or that type of thing in our portfolio. So, while, in general, I'd be worried about that, when you get specific to our portfolio, I'm not as concerned. Got it. And just back to office quickly, I guess how big is the typical office loan you guys are doing? What's sort of the average loan size in the office book? Well, I can tell you I did not bring that with me, but I can tell you the average loan to value is 53%. So, we've got a fair amount of room to move. I'll be happy to follow-up and give you the average loan size as well. Great. Okay. Thank you. And we'll move -- I'll move on to another question. Charles, the tax rate, obviously, touched on just pretty low this quarter, but what can we expect for 2023? Would it stay at this, I think, 19% level or be even higher than that? Not quite that low. Yes, not quite that low. My expectation is it will be somewhere in the neighborhood of 22% to 23%. Again, this is as a result of the updated analysis associated with the apportionment factors. But yes, I think that's probably a safe run rate as we look forward to all things to continue. Okay. Got it. I'll just ask one more and let someone else jump on. But just as far as sort of FHLB advances go, is there the level you guys are targeting? Or is that just going to be dependent on loan opportunities? Curious just your strategy around that. And also how you're thinking about the loan deposit ratio? Are we kind of comfortable with that going back to like the 100% range, or is there any target? Or sort of just walk us through how you're thinking about just various funding sources. Yes, sure. The FHLB is actually, I think, it's more of the liquidity management tool. As of today, or actually as of couple of days ago, it's actually fully paid back. We're down to zero on that. We do have -- due to that kind of volatile nature of some of -- or maybe the volatile is not the right word, just the fluctuations we see in some of the commercial business that we bank, we historically, in the last couple of quarters, had to borrow from the FHLB for liquidity purposes towards the end of the quarter and that may continue. But again, it's more of a liquidity management tool. In terms of the loan to deposit ratio, we're actually, obviously, sitting on a very large investment portfolio right now; book value of $2.9 billion. We're going to continue to see cash flow roll off of that, and likely the venue for that cash is going to be deployed into new loans that we're seeking out. So, I could easily see us getting back into the, call it, upper 90%-s in terms of the loan to deposit ratio, but it's a walk to get there. I just want to start on just the margin and thinking about big picture outlook. There's been a lot of the narrative, I think, from a lot of the other banks we've seen this quarter has been that -- this quarter or maybe next is where we're seeing peak NIM and then the margins are kind of flat to maybe even down as you move through back half of the year as deposit costs continue to ramp. As I think about you all, you've had some of the higher betas early on. And so, how do you think about that just kind of big picture holistically? Is there an argument to say that you still have more room for margin expansion as we kind of move through the year? Or are you in the campus with most of your peers where we're kind of at or near peaking NIM today? Thanks. Sure then, Catherine. I think, it will be pretty significantly dependent on Fed action. Right now, I think futures markets are suggesting a pretty high probability in the mid to high 90%-s that we're going to see 25 basis points in February and then another 25 in March. We're still asset sensitive. Over a 12-month period, 100 basis point shock on a static balance sheet sees net interest income expansion of 9.9%, almost 10%. So, I would expect there to be additional tailwinds to that. We're through the floors. So, I think there's positive momentum should rates continue to go up. So, hopefully that's responsive. Yes, that's helpful. And maybe within that I'm just thinking about the deposit cost, do you have any more color you can give us on just kind of what current rates are, not for the full quarter, but maybe today or at quarter-end just for your different types of deposit costs? Like where current CDs coming on, where money market on average are at the end of the quarter, just to give us a sense as to where we might be going into the first quarter? Sure. Yes. We -- so, we booked gross CDs for the quarter of about $309 million. The weighted average coupon on those was actually just over -- about $409 million. The weighted average maturity on those was 19 months, just over a year-and-a-half. So that's where those CDs are coming on. Our top-tier money market rate today is at $310 million. So, we feel those rates are pretty competitive. We want continue to encourage deposits into the bank. It does seem like the entire banking system, as rates continue to push up, are losing some of the battle for funding. So, we want to offer that compelling case for folks to keep their money here in addition to the service and relationship banking that we can offer. So that's kind of the state of the union on [indiscernible]. And I would [Multiple Speakers] Yes. Just to add on the -- we continue to model at a beta of 70%, as I mentioned, and I've mentioned in prior calls. We were just north of that, at about 74% this quarter. My hope is we can still maintain that, but I think as rates get higher and competition heats up, that gets more difficult. And any commentary on just anecdotes you're seeing within your noninterest-bearing accounts in your expectations for potential outflows out of that this year? No, I mean, certainly, there's -- you saw some kind of initial disintermediation out of noninterest-bearing deposits, but we've been able to maintain. Right now, we're at about 41% of average -- of our average deposits are DDA, some relatively decent stickiness that we've seen there. So, our hope is that we can continue to maintain that and serve those customers and keep those deposits here. But it gets harder for them too, right, to justify that not earning interest on those deposits. That's the other challenge is what's going on their side of the [business] (ph). Thank you. [Operator Instructions] Our next question is coming from Christopher Marinac of Janney Montgomery and Scott. Your line is open. Hey, thanks. Good morning. I wanted to ask about the use of wholesale funds and just debt overall on the balance sheet. Would that percentage continue to rise? Or is there an upper bound to how high you'd like it to go? Again, as I mentioned, I look at the FHLB line more as a liquidity management tool. Those funds are actually fully paid down at this point. And there -- we've had historically over the last couple of quarters the need to bring on overnight funding in order to bridge a gap given some of the fluctuations that we have in some of our commercial deposits. That may continue again depending on our success of gathering deposits and additionally, as I mentioned, cash will continue to roll off the investment portfolio to -- are being able to fill needs there may also play into a factor. But ideally, we're hoping to maintain relatively similar mix to where we are now on an average basis, I would say, and just be successful in our core deposit gathering. Great. That's helpful. And I was just going to ask about the core deposit. So, do you have any metrics that you're tracking in terms of net new accounts or just the core business accounts that, again, may not necessarily be a phenomenon in Q1, but just in general the opportunity to get new core funding in the bank for this next year? Not -- I think, we're divulging publicly any of that -- those kinds of detailed metrics. But it is a constant effort. Again, we want to make sure that we're letting both existing and prospective customers know that we have a strong value proposition in terms of the customer service and the relationship banking that we can offer. It's a constant messaging that we're out there in the marketplace doing so. Our expectation is that we'll be able to continue to provide those services and grow those deposits and grow those relationships. Great. Thank you. I understand. I appreciate that feedback. And then, just a quick question for Jan. As you think about sort of classified and criticized assets this year, would it be normal for those to modestly go up? Or is there a scenario that you could see them be stable all this year? Well, there is a scenario where I could see it hold stable, but I think there may be some volatility in that. Right now, we don't have anything in the classified or criticized asset category this office, but we do have a special mention property that we're working through. Anything is possible, but we will be diligent in pursuing early intervention and working through any potential issues that do come up. Thank you. I would now like to turn the call back over to President and CEO, Susan Reel, for closing remarks. Thank you. We appreciate your questions and you're taking the time to join us today on this call. We look forward to speaking with you again next quarter. Have a great day.
EarningCall_1420
Good day and welcome to the East West Bancorp Fourth Quarter and Full-Year 2022 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note, this event is being recorded. Thank you, [indiscernible]. Good morning, and thank you, everyone, for joining East West Bancorp's fourth quarter and full-year 2020 earnings call with Dominic Ng, our Chairman and Chief Executive Officer; and Irene Oh, our Chief Financial Officer. This call is being recorded and will be available for replay on our Investor Relations website. During their remarks, Dominic and Irene will reference a slide deck that is available on our Investor Relations site. Management may make projections or other forward-looking statements, which may differ materially from the actual results due to a number of risks and uncertainties, and management may discuss non-GAAP financial measures. For a more detailed descriptions of the risk factors and a reconciliation of GAAP to non-GAAP financial measures, please refer to our filings with the Securities and Exchange Commission, including the Form 8-K filed today. Thank you, Julianna. Good morning, and thank you everyone, for joining us for our earnings call. I will begin the review of our financial results with Slide 3 of our presentation. Our strong financial performance in 2022 was characterized by strong revenue growth, which was driven by strong loan growth and net interest margin expansion in a rising interest rate environment, combined with disciplined expense management, and solid and stable asset quality. Together, all these drivers result in industry-leading profitability, both for the full-year and the fourth quarter of 2022. East West achieved record earnings of $1.1 billion or $7.92 per share for the full-year of 2022, an increase of 30% year-over-year. Our 2022 total revenue of $2.3 billion was our highest ever and grew 29% year-over-year. Our pretax pre-provision income of $1.6 billion grew 40% year-over-year in 2022. We returned a 1.8% on assets and 21% on tangible equity for the full-year. Now, for the fourth quarter of 2022, we reported net income of $337 million and earnings per share of $2.37, which grew 55% annualized quarter-over-quarter. Our industry-leading returns were 2.1% on assets, and 25% on tangible equity for the fourth quarter. Our fourth quarter pretax pre-provision profitability was nearly 3%. Now let's go to Slide 4, and Slide 4 presents a summary of our balance sheet. As of as of December 31, 2022, total loans reached an all-time high of $48.2 billion, an increase of $771 million or 6% annualized from September 30. Fourth quarter average loan growth was likewise 6% annualized. Average loan growth in the fourth quarter was well balanced between our major loan portfolios of commercial real estate, residential mortgage, and commercial and industrial. Total deposits were record $56 billion as of December 31, 2022, an increase of $2.1 billion or 16% annualized from September 30. Fourth quarter average deposit growth was 7% annualized. Growth was driven by time deposits, reflecting a successful branch-based CD campaign during the fourth quarter. Our deposit book is well diversified by deposit type and 38% of total deposits were in noninterest-bearing demand deposits as of December 31. Our loan-to-deposit ratio decreased to 86% as of the end of the year from 88% as of September 30. Turning to Slide 5. As you can see in the exhibit on this slide, all our capital ratios expanded quarter-over-quarter. As of December 31, 2022, we had a common equity Tier 1 ratio of 12.7%, a total capital ratio of 14% and a tangible common equity ratio of 8.7%. Quarter-over-quarter, our book value and our tangible equity per share increased 6%. I'm pleased to announce that East West Board of Directors approved a 20% increase to the quarterly common stock dividend from $0.40 per share to $0.48 per share and equivalent to an annual dividend of $1.92 per share. The new dividend will take effect in the first quarter, payable on February 21, 2023, to stockholders of record on February 6, 2023. Moving on to a discussion of our loan portfolio, beginning with Slide 6. As of December 31, 2022, C&I loans outstanding were $15.7 billion, sequentially up 2% annualized, and up 11% year-over-year. Our C&I portfolio is well diversified by industry and sector. Slide 7 and 8 show the details of our commercial real estate portfolio, which is well diversified by geography and property type and consists of low loan-to-value loans. Total commercial real estate loans were $19.1 billion as of December 31, 2022, up 8% annualized from September 30 and up 18% year-over-year. In Slide 9, we provide details regarding our residential mortgage portfolio, which consists of single-family mortgages and home equity lines of credit. Our residential mortgage loans are primarily originated through East West Bank branches. I would highlight that 82% of our HELOC commitments were in a first lien position as of December 31, 2022. Residential mortgage loans totaled $13.3 billion as of December 31, 2022, up 9% annualized from September 30 and up 19% year-over-year. I will now turn the call over to Irene for a more detailed discussion of our asset quality and income statement. Irene? Thank you, Dominic. I'll start with our asset quality metrics and components of our allowance for loan losses on Slides 10 and 11. The asset quality of our portfolio continues to be stable and strong. Quarter-over-quarter, criticized loans decreased 1% and the criticized loan ratio improved 5 basis points. Both classified and special mention loans decreased from already low level as of September 30. At year-end, the nonperforming asset ratio was 16 basis points of assets unchanged quarter-over-quarter. Charge-offs continue to be a low loan. During the fourth quarter, we recorded net charge-offs of 10 million or 8 basis points, compared with net charge-offs of 6 basis points in the third quarter. Our allowance totaled 596 million as of December 31 or 1.24% of loans, up from 1.23% as of September 30. During the fourth quarter, we reported a provision for credit losses of 25 million, compared with 27 million for the third quarter. While asset quality remains strong and the current credit environment is benign, we continue to remain vigilant about credit. We are actively managing the loan portfolio and taking proactive measures to build our allowance for loan losses. And now, moving to a discussion of our income statement on Slide 12. This slide summarizes the key line items of the income statement, which I'll discuss in more detail on the following slides. Of note, amortization of tax credit and other investments in the fourth quarter was 65 million, compared with 20 million in the third quarter. At the same time, the quarterly effective tax rate was 13% in the fourth quarter, compared with 23% in the third quarter. This fluctuation is due to tax credit investments that were closed in the fourth quarter and the related projects that were placed into service. This resulted in a lower effective tax rate and an increase in the amortization expense for the fourth quarter. For the full-year of 2022, the effective tax rate was 20%. I'll now review the key drivers of our net interest income and net interest margin on Slide 13 through 16, starting with average balance sheet. As Dominic mentioned in his remarks, fourth quarter average loan growth of 6% annualized was well balanced among our major loan portfolios and average deposit growth of 7% annualized reflected a successful branch-based deposit campaign. Our average loan-to-deposit ratio was stable quarter-over-quarter at 87%. Average noninterest-bearing demand deposits made up 39% of our average deposits in the fourth quarter. Turning to Slide 14. Fourth quarter 2022 net interest income of $605.5 million was the highest quarterly net interest income in the history of East West, growing 39% linked quarter annualized. Our net interest margin of 3.98% expanded 30 basis points quarter-over-quarter. As you can see from the waterfall chart on the slide, net interest margin expansion in the fourth quarter reflected the impact of higher loan and earning asset yields, which increased the net interest margin by 82 basis points, partially offset by 52 basis points of compression from the funding side. Our net interest income growth benefited from rising benchmark interest rates because of our asset-sensitive loan portfolio. To preserve net interest income when interest rates go down, we added 3.25 billion of swaps and collars in 2022, which included 1 billion added early in the fourth quarter. Turning to Slide 15. The fourth quarter average loan yield was 5.59%, an increase of 84 basis points quarter-over-quarter. The average loan yields comprised an average coupon yield of 5.53%, plus yield adjustments, which contributed 6 basis points to the overall loan yield in the fourth quarter. As of December 31, the spot coupon rate of our loans was 5.92%. In this slide, we also present the coupon spot yields for each major loan portfolio for the last five quarter end. You can see the positive impact of rising interest rates on each of the loan portfolios as loans have repriced. In total, 61% of our loan portfolio was variable rate, including 30% linked to the prime rate and 27% linked to LIBOR or SOFR rates. I would also highlight that over 40% of our variable rate commercial real estate loans have customer level interest rate derivative contracts in place. To clarify, this is distinct from the balance sheet hedging I discussed a minute ago. With the customer level derivative contracts, we've helped our customers enter into low level interest rate swaps, collars and caps, currently structured to help protect customers against rising debt service costs. At the same time, the loans remain variable rate on our balance sheet and the bank benefits from the asset sensitivity. Turning to Slide 16. Our average cost of deposits for the fourth quarter was 106 basis points, up 55 basis points from the third quarter. Our spot rate on total deposits was 134 basis points as of December 31, a year-over-year increase of 125 basis points. This translates to a 29% cumulative beta relative to the 425 basis point increase in the target Fed funds rate over the same period. In comparison, the cumulative beta on our loans has been 58% as our loan coupon spot rate increased 248 basis points year-over-year. We started the rising interest rate cycle from a position of strength with historically high levels of demand deposits for East West Bank and strong liquidity. This has bolstered the asset sensitivity benefits of our variable rate loan portfolio supporting strong revenue growth through the cycle. We are pleased with the lag in deposit beta cycle to date. This has come through careful deposit cost management. With a 29% cumulative beta cycle to date, we are outperforming prior rising interest rate cycles. With 39% of our average deposits and interest-bearing accounts and with the growth that we have had in treasury management products and services since – for the pandemic, we feel comfortable about continuing to navigate the current cycle well. Moving on to fee income on Slide 17. Total noninterest income in the fourth quarter was 65%, down from 76% in the third quarter. Customer-driven fee income and net gains on sales of loans were $66 million, down 4.5% or 18% annualized from the third quarter and up 4% from a year ago. Year-over-year, we saw growth across most of our fee income lines of business. Moving on to Slide 18. Fourth quarter noninterest expense was $257 million. Excluding amortization of tax credits and other investments and core deposit intangible amortization, adjusted noninterest expense was $192 million in the third quarter, down 2% quarter-over-quarter or 7% annualized, driven by lower compensation and employee benefits expense. Once again, we generated strong positive operating leverage, with total revenue growth of 27% annualized in the fourth quarter, plus a sequential decrease in expenses. The fourth quarter adjusted efficiency ratio was 29%, compared to 31% in the third quarter. Our adjusted pretax pre-provision income grew 43% linked quarter annualized, and our pretax pre-provision ROA was an attractive 2.95% in the fourth quarter. And with that, I'll now review our updated outlook for the full-year of 2023 on Slide 19. For the full-year 2023, compared to 2022, we currently expect year-over-year loan growth in the high-single-digit percentage range. We expect production from all of our major loan portfolios in 2023. Year-over-year, we expect net interest income growth in the low 20% rate range. Underpinning our interest income assumption is the forward interest rate curve as of year-end, which assumes a peak Fed funds target rate of 5% by April 2023 and the year-end Fed fund's target rate of 4.75% with the cut late in the year. In our modeling, we assume that deposit betas will continue to rise in 2023. Adjusted noninterest expense growth, excluding tax credit and investment amortization in the range of 10% to 11%. We expect our revenue and expense outlook to result in positive operating leverage year-over-year. In terms of credit, for 2023, the provision for credit losses will largely be driven by changes in the macroeconomic outlook. We are providing our expectations for gross charge-offs, which are expected to be in-line with our recent gross charge-off experience if macroeconomic conditions stay stable. For context, the gross charge-off ratio was 8 basis points in 2022 and 17 basis points in 2021. Asset quality today is excellent, and the potential losses from any problem loans are limited. However, realistically, if the economic backdrop weakened, we would expect to see some credit normalization from the very low levels today. In terms of tax items, we currently expect that approximately $150 million of tax credit investments, excluding low income housing tax credit will close to go into service in 2023, and therefore, be part of our tax rate calculation for the full-year. The tax credit amortization related to these tax permits should be approximately 95% of the tax credit investment amount for the full year. For the first quarter of 2023, we expect that $92 million of these tax credits will be reflected in the tax rate calculation and the tax credit amortization to be approximately [22 million] [ph] for the quarter. There will be quarterly variability in the tax rate and the tax credit amortization, due to the timing of tax rate investments placed into service. Thank you, Irene. In closing, 2022 was an excellent year for East West with our highest ever earnings, revenue, loans and deposits, and the achievement industry-leading profitability metrics. Our annual earnings now exceed $1 billion. We look forward to 2023 with excitement as we celebrate our 50-year anniversary. The bank and our customers have come a long way since 1973. Throughout our history, the pillar of our success has been and continues to be our spirit of going above and beyond to service our customers. We are honored to be the bank of choice for our clients and wish to thank all our associates for their dedication and contribution to making our bank a success. Lastly, I want to take this opportunity to wish everyone a happy Lunar New Year. May the Year of the Rabbit bring health, prosperity, and happiness to all of us. Hi good morning guys. Nice quarter. My first question is on the NII guide. On Slide 16, you guys highlight the total deposit beta 29%, you've got 47% interest-bearing deposit beta during the last year. I was wondering what the positive beta you're baking into the guide at this point? I know you mentioned you expected deposit betas would rise through this year. But are you thinking mid-30s or upper 30s for the overall cycle, are you making it something higher than that? And then how do you think about deposit growth from here and what that means for borrowing levels, which are still very low? Thanks. Yes. Great question, Dave. At this point in time, we're modeling the full cycle beta will be 40% for 2023 and at the same time for interest-bearing deposits, a deposit beta of 60%. And that's factored in with our NII guidance that we have of the increase in the low 20%. Overall, I think with the good growth that we've had in deposits in general, along with our successful campaigns for CDs that are lower than other competitors in the market, at this point in time, I think we'll be able to continue to fund our loan growth with the deposits. Certainly, we're very opportunistic to look at that from the perspective of cost. Great. And then just one follow-up. On the back end of the year, when you include your Fed rate cut, I was curious what you're expecting for the deposit cost movement as a result of that cut. Are you thinking that you'll get immediate benefit or are you thinking there might be a little bit of a lag there with the first couple of cuts? Thanks again. Yes. I think it's still late in the year at this point. The expectation around that, we're not baking that in, Dave. I wanted to ask on the hedges that you've been putting on, on the books. Can you speak to how those might impact loan betas for both the remaining of the rate cycle, the rate hike cycle and also when the Fed begins cutting rates and also how much more you plan to do on your hedging efforts from here? Yes, great question. Certainly, the specifics of how much that's impacted us, [quarter-to-date] [ph], I do not have that, but we can get that information after the call. Certainly, as we started adding this fourth quarter, third quarter, there was a little bit of an impact as far as largely against the CRE loans that we’ve kind of hedged. We have 3.25 billion of swaps and also collars that we put on. At this point in time, in discussion with our ALCO Committee, there's probably another couple of million that we would look to do, but certainly, we're opportunistic about this and also evaluating the overall balance sheet and the positioning of that. So, that's something that we'll continue to evaluate to see what we think makes the most sense given the changes in the interest rate environment as well. Got it. And is there a bottom we can think about on NIM in the event the Fed begins cutting or is that too early to say right now? Fair enough. And then just on credit, in November, you emphasized like everyone else, you've been watchful for a normalization on credit. And you're focused on early detection of any cracks, in the reviews that you've been making, have there been any covenant breaches or any other cracks to note? I mean, I think certainly on an individual loan basis, that is happening, right. But overall, I think we're very positive from the perspective that on credit as we do continue to do these reviews on our commercial books, our consumer books throughout, what's positive is there are not a lot of new problem loans, same loans that we're working through last couple of years continue to be things that we work through. Not a lot of new problems in that process. So that's certainly something that we feel is positive and positions us well. Yes, we've been actively managing the loan portfolio overall. So, as you can see in the criticized asset percentage, is relatively benign. So far, surprisingly asset quality very, very good. And we look at the rising interest rate, obviously, that's why we've been aggressively managing the portfolio and see how it goes and I always do this ongoing loan review and so far, so good. Hi, good morning. I guess maybe just sticking with asset quality. So, I appreciate that what you just said, Dominic, you haven't seen any [steps] [ph] within the portfolio, but is that a timing issue or in Slide 15, you're showing how interest rates yields have gone up on these loan portfolios? Is it a timing issue or do you feel good about the loan book and your ability of these borrowers to absorb where – if the Fed funds were to peak out at 5%, they should be able to handle this where it doesn't become a credit issue for East West? Like, do you feel good about that? Do you have visibility into that? Well, when it comes – when you say timing issue, we obviously – when we do our stress tests on these real estate, we're obviously projecting. So, it's not something that we're just looking at as of today, whether they can handle and so forth. So, from that perspective, we feel pretty good about the liquidity level of our clients in terms of the cash flow that they've been getting from the existing business. So, I guess in a way that what we notice is that the cash flow is still pretty good. I think it's really coming back down to the economy. The economy is still strong. Now, if you looked at it – we project a much more deteriorating economy, that will be very different. At this point, we don't see it. Things are going pretty well. Got it. And I guess just separately, in terms of loan growth, so I appreciate the lower growth guidance, but just talk to us in terms of what are the pockets, I know Irene mentioned you expect loan growth across categories, but any particular verticals, any markets where you're seeing more strength and more market share opportunities as we think about growth and maybe potential for upside surprise on that growth? I think, overall, we have always been very focused in having a more diversified group. So, from that standpoint, there's always going to be one particular industry vertical or here and there that seems to do a bit better than the others. However, overall, if it gets too far, we ran it in any way. So, in that standpoint, that's why you always see a much more even till more diverse type of loan portfolio that we have here is because we actually manage it. So – but I would say that, I mean, just looking at maybe a couple of weeks so far, we do have a few more like private equity, capital call line commitments that we have originated, but I would expect that if we continue to go in that direction, we’d probably have a stronger PE loan growth. And then also last year that we actually have, surprisingly, pretty decent growth from our Greater China region and so despite the pandemic, and so, we expected that they may be able to continue to do quite well. Now, obviously, they have a much smaller balance sheet, but as a percentage growth, they're doing pretty well. So, we may have a few other different areas that we'll be able to step-up because we also have a very strong competitive teams within the organization, everybody wanted to do better. So, we just expect that different team will step up in different quarters. So, I wanted to kind of touch again on the NII guide and in particular your outlook for the trajectory in the HS margin. It appears if the margin stays flat from 4Q levels, you could potentially hit the guidance just from that. I'm curious what your assumptions are, as far as the trajectory of NIM going through the year and also your – with the forward rate curve assumptions? Yes. I think at this point, my focus is really more on the NII, Brandon. We do expect when we look at our guidance, you can tell, you can do a math of our guidance as well, that we do expect the NII to grow from the fourth quarter level. Then it depends really more about the fluctuation of what happens per quarter, but both, we expect to be positive in 2023. Okay. And then in regards to your outlook for deposit growth, what areas or what categories of deposits do you see most of that growth coming from? And could you talk more about your ability to, kind of mitigate losses in DDA? Yes. Great question. When we look at our deposit portfolio and our customers, one of the things that we benefit from is just the diversity of customers we have. Certainly, in order to candidly remain competitive, we have these deposit CD campaigns in the fourth quarter. And we have one right now priced below market, but attractive enough rate and also six month duration. We don't want that to go too long. And so that is something that we continue to do relative to other, kind of funded costs right now. We think it's attractive. It's also a customer base that stays with us and has a larger relationship with us. When we look for 2023 and where we think deposits are going to grow, I'd say across the board. Although realistically, in this kind of rate environment, it's hard to maintain the deposit balances in the DDA accounts at the level that we have pre-rising rates, you know we are still onboarding new customers all the time. Pipelines are strong on the deposit side. So, we are very, kind of positive about what we're doing. The investments that we've made in treasury management, cash management, product services certainly are something that we're seeing a benefit today. I wanted to highlight also, I think at the height of excess liquidity, which is during PPP time, back in late 2020 because of COVID, we had like maybe went all the way up to close to 43% as a percentage of DDA to the noninterest-bearing deposit to the entire deposit portfolio, 43%. Today, we're down to 38%. So, as you can see, there was a lot of liquidity there, but by nature, even if the interest rate rising and so forth, you will expect that the success and liquidity would not be sustainable. So, we are actually very, very pleased throughout the last few quarters, watching our noninterest-bearing deposits and see what the percentage [stand], and it's kind of each quarter drop 1 basis points and so forth. And then so far, so good. So, we dropped now to 38%. It's still 38%. That's a lot of noninterest-bearing deposits sitting there. And by the way, the other part is that, we continue to bring in new customers. We continue to bring new commercial customers. We're still onboarding this new relationship one at a time. So, in time, it will continue to grow the noninterest-bearing deposit. It's just that there are some excess liquidity that in relationship with the market rate in terms of deposit, it is today. Naturally, there are people who are moving some of the, maybe excess liquidity to put into whether money market accounts or maybe CDs account and so forth. So, that's why you see that there is some gradual reduction on noninterest-bearing deposit balance, but in terms of number of accounts, they keep going up. Yes, thanks. Good mornings guys. Just wanted to follow up on the loan growth outlook. Was wondering how – what you guys were assuming for utilization rates in your guide? And then any color on how loan pipelines are shaping up versus [9.30] [ph]? Yes. At this point in time, we're not assuming a change in utilization rates, Casey. We're assuming flat from where we're at. Okay. Understood. And then on the credit quality side, everything is still pretty benign and holding stable. I was wondering, is that true also for the $2 billion exposure in China, which obviously gets a lot of attention from investors? China is even better. So, we always have a very, very strong pristine loan portfolio. And so, it's still exactly the same. So, we feel that with the economy opening up, I think it was only going to help us better. While we don't expect that there will be some sudden surge of loan origination in 2023 because while the economy opened up, it's going to still take a little bit time for the business to, sort of get back on track. It will probably benefit us more in 2024 than 2023. Hi, good morning. This is Clark Wright on for Gary Tenner. I don't want to beat a dead horse, but just in terms of the loan growth again, are you expecting it to be front-end loaded or [indiscernible] across the quarters? We're assuming that it isn't front-end loaded. That will be throughout, maybe a little bit more in the latter half of the year. Hi, good morning. Dominic, on capital, I think the dividend was a pretty strong signal given how much capital you have and the position you're in. Is that the, really the only capital return that you're contemplating right now given the economy? I know you've been resistant to the buyback, but just wanted to see if there's any change in [tone] [ph] there? Yes, we did 100 million in the second quarter 2022. We still have 254 million outstanding that we can execute anytime we want because it's been approved by the Board last year. And we are very opportunistic in terms of the buyback. You have to look at it is that fourth quarter, we just [raked up] [ph] 25% return on tangible equity. So, we obviously, it's not one of those things that really need to do this. However, we have always shareholders-friendly. So, if we ever see that there's great opportunity, we absolutely will use the capital at the right moment. I thought what we did in the second quarter for the 100 million was a great execution because at that time, at that price, sure, I will jump right at right at it. So – but we have to be also be mindful. One of the great advantage of East West Bank, you look at our capital ratio today. And this is very, kind of somewhat benign economic environment. And we – because of the interest rate that we are doing extraordinarily well from a return of equity and return of asset standpoint. However, had this been a completely different economic situation, had it been like a 6%, 7% unemployment rate, interest rate were in a much higher level that business we're having trouble. We, at that point, having this, kind of capital absolutely give our customers much stronger confidence about why they wanted to be banking with East West than the others. So, I was always mindful of that. This has been doing really, really well for us back in 2008 and 2009 during the global financial crisis, somehow, somewhere, we just have a bit more capital than our peers. And so, ultimately, customers feel more comfortable with us. So, we've always been very mindful of that. So, that's one key reason. The other thing is that, we don't want to – not have some excess capital just in case if there are even potential acquisition opportunity and so forth. So, we are very choosy in terms of potential acquisition. However, if there is something available, we're always ready to execute. So, all of that is a combination of multiple factors that cause us to be where we are today. And – but one way or the other, we are very comfortable where we are. And if it ever in a situation that we feel that the stock price or whatever the other reason that we feel or maybe somehow there's not enough of a confidence of growth that we may want to do some buyback, we absolutely will step-in. We’ll do the right thing. So, you can count on that. Yes. Thank you for this perspective. Thanks, Dominic. Just, I do want to ask the tax rate. I'm not the tax expert, but I want to make sure I understand the cadence of the amortization. So, Irene, you said roughly 95% of the 150 million will flow through [indiscernible], just like a little over [140 million] [ph]. And I think the Q1 is a little over [20 million] [ph], can you help us with the tax rate? Because it looks like amortization last year was a decent amount lower and the tax rate was 20. So, I'm coming to a tax rate, kind of mid-to-upper teens based on this guidance. I just want to make sure I don't make a mistake. Thank you. Hi, Chris. This is Julianna. In terms of the tax rate, it will vary depending on your assumptions for pretax income, which will vary with your assumptions for provision for credit costs, obviously. In terms of the tax amortization on a full-year basis, when you look at that 150 million of tax credits, think of it as 95% of that will go into the tax grade amortization. However, we booked amortization when the credits close and go into service. Therefore, for what's on the docket for the first quarter, that's 22 million. That means amortization rate in quarters 2, 3, and 4 will be higher in order to come up into that full year 95% number as credits close and go into service. So, we wrote in the slide deck for the first quarter, 92 million of tax credits will be in the tax rate calculation and that will go on up through the year. And I can follow up with you offline for a more detailed calculation, if you like. Hi, good morning. Thank you. I guess when you look at the moves you've made with swaps and collars and the potential to add more, is your goal to get – to sort of eliminate all that asset sensitivity earlier or much of that asset sensitivity earlier in 2023 or how should we be thinking about just your general asset sensitivity positioning over the first few quarters? Yes, great question. I would say that, that isn't our goal, Jared, to remove our asset sensitivity. What we want to make sure is that when we look at the balance sheet and the loan portfolio, that we are able to evaluate what we think might happen, hedge kind of risks that we see from interest rate perspective, but we still expect to be asset sensitive even with these changes that we're making. Okay. And then my follow-up, any outlook on the fee income lines and what you're seeing in terms of potential for growth there among the different lines? Yes. Great question. On the fee income, I would say the areas that or – if you break that down as far as things that are within our control, things that have to do with investments that we've made, growth that we see with our customers, that's going great. Market, kind of driven factors, things that maybe we don't have a control over, I think that's going to continue to be challenging, especially if you look at it from the perspective of mark-to-market on the derivatives and then also effects and that balances around. But aside from that, we expect that from a core customer perspective and a growth perspective, we'll still see those increases. Hi, thank you. I guess just wanted to follow up on China in terms of, one, given the reopening that's underway in China, does that create maybe stronger growth opportunities as we think about this year? And how are you thinking about allocating more capital to that business. And I appreciate a lot of the business is, kind of cross-border and this cross-border connectivity, but would love to hear if there are increased growth opportunities emerging in China? And also Dominic, I would love to hear your views, I mean, as is now the Chair of APAC, like how do you see that relationship evolving and creating more opportunity for the bank given its strategic positioning? Thank you. In terms of the opening of China, it's not just like a, sort of like a post pandemic opening that the ability to travel in and out of China and so to help the foreign investments to do at least about the – not having the restriction to do quarantine and so forth. That's actually a big factor because many of our management team have not been back to China for the last two, three years. And so, I think that, likewise, the same thing for many of the business who around the world who are doing business in China, and they were restricted by that. And then with this opening up, I think that's a huge factor that helps substantially, that's one. The second part is really the Chinese government new policy towards business. Obviously, the last two or three years, the business sectors, we are having some hard time whether you are in social media, high-tech, video gaming, entertainment, real estate, education, you name it, every one of these sectors were hammered because of a much more challenging policy or regulation that came up that hinder their ability to grow. Now, just for the last few weeks, things turn in a completely different direction. Government are providing support to the real estate sectors. They're also really getting much more business friendly to these other industries, et cetera. And so with that, we also see that foreign investments are getting their license approved and getting their – let's say, additional investment to get majority shares also sign-off and so forth. So, we do see that at this stage, the business opportunity is much better. Now, then reflected on East West Bank, we have always traditionally been mainly focusing on our cross-border business. And so, I think that with this additional opening up and the more business-friendly, kind of policies, clearly, it would encourage cross-border business. Please keep in mind that despite the – from the U.S. side that we can see that maybe that attitude towards China has not improved. But on the other hand, we ought to keep in mind is that the business that has been restricted are usually related to national security issues, the highly sensitive or maybe some very, very high-level technology or biotech type of business that, quite frankly, the East West really do not have anything to do with. And our focus is on this very, very common, like electronics, [garment] [ph], and business items that import export or investment to [indiscernible] that to the consumer market and et cetera, that are not related to national security issue. So, we do feel that there are plenty of room to grow even during the pandemic when China literally was shut down against – by the borders. We still find a way to grow our loans. We still bring in additional new customers. So, we expect that to continue to grow, but I don't think that East West will be an organization that just because of this new opening that we would just rapidly trying to push a lot of capital in there, and we're going to continue to stay steady and will continue to be observing the market and make sure we make the wise choice. But I expect that in terms of a sustainable growth opportunity in the Greater China region and also particularly, as you mentioned, throughout Asia, we feel pretty confident that, that will be something that we expect a good opportunity going forward because the Chinese business also have expanded into Southeast Asia, whether it's Vietnam, Thailand, Indonesia, Malaysia, et cetera. So, we expected that many of our customers who continue to migrate their business into those regions, which will be beneficial to us. And that's also the reason why we opened a [rep office] [ph] in Singapore. So, we will continue to evolve and expand into Asia and to make sure that we can effectively grow this business model as the bridge between the East and the West. This concludes our question-and-answer session. I would like to turn the conference back over to Dominic Ng for any closing remarks. Well I just want to thank you all for joining us for the call today, and we feel really good about where we are today in 2023, and we'll continue to march forward and looking forward to the call with you all in April. Thank you.
EarningCall_1421
Good afternoon, everyone. Welcome to NIKE, Inc.'s Fiscal 2023 Second Quarter Conference Call. For those who want to reference today's press release, you'll find it at investors.nike.com. Leading today's call is Paul Trussell, Vice President of Investor Relations and Strategic Finance. Before I turn the call over to Mr. Trussell, let me remind you that participants on this call will make forward-looking statements based on current expectations, and those statements are subject to certain risks and uncertainties that could cause actual results to differ materially. These risks and uncertainties are detailed in NIKE's reports filed with the SEC. In addition, participants may discuss non-GAAP financial measures and non-public financial and statistical information. Please refer to NIKE's earnings press release or NIKE's website, investors.nike.com, for comparable GAAP measures and quantitative reconciliations. Thank you, operator. Hello, everyone, and thank you for joining us today to discuss NIKE, Inc.'s fiscal 2023 second quarter results. Joining us on today's call will be NIKE, Inc. President and CEO, John Donahoe; and our Chief Financial Officer, Matt Friend. Following their prepared remarks, we will take your questions. We would like to allow as many of you to ask questions as possible in our allotted time. So we would appreciate you limiting your initial question to one. Thanks for your cooperation on this. Thank you, Paul, and hello to everyone on today's call. We delivered a strong quarter in Q2 with revenue growth of 17% on a reported basis and 27% on a currency-neutral basis. And looking at the quarter's results, we delivered our Q2 expectations on revenue, profitability and inventory. In this current environment, our consumer demand stands out. Today, we're creating more separation between us and our competition. Thanks to the meaningful relationships we have consumers and the continued success of our strategy. Our Q2 growth was broad-based across our brands, channels and geographies. We had strong double-digit growth across both our partners and our direct business, which was once again led by our industry-leading digital performance. The quarter saw more than 30% currency-neutral growth in our North America, EMEA and APLA geographies. And after nearly two years of unprecedented disruptions, Greater China grew 6% on a currency constant basis, translated to minus 3% on a reported basis due to foreign exchange. Clearly, our brand continues to not only be top of mind, but prioritized by consumers around the globe. In addition to our results, we're executing in the areas we spoke to 90 days ago as we take decisive action to clear excess inventory. We believe the inventory peak is behind us as actions we're taking in the marketplace are working. Later in the call, Matt will share more about our progress on inventory in North America and a return to healthy inventory levels in China. So overall, our Q2 results give us confidence that we will deliver the year, and we remain on a path toward our long-term goals as well. Our current headwinds, such as foreign exchange and inventory challenges are transitory, but our tailwinds are structural. Like the expanding definition of sport, the consumers move toward digital and the cultural shifts toward comfort and health and wellness. More importantly, our results speak to how we've leveraged our competitive advantages which include a relentless innovation pipeline, match brands and deep consumer connections to build relative strength and stay ahead of competition. As you heard me say before, at NIKE, it all starts with product innovation. And this quarter, I'd like to highlight an important part of our culture of innovation, our constant pursuit to improve on our most popular platforms. We win with product because we know it's not only about individual innovations, but also about our ability to continuously bring newness to our greatest franchises. For instance, earlier this quarter, we launched the LeBron 20 to strong consumer response. What's unique about the LeBron 20 is that its LeBron's first signature shoe to debut as a low-top. Driven by consumer insight and performance demands from LeBron himself, this style combines innovation with sportswear design to create greater commercial appeal with its ability to be worn on the court and off. And we're not just bringing innovation and excitement to existing franchises; we continue to expand the portfolio. Coming soon, we've got some exciting signature debuts in NIKE Basketball and Jordan brand that we can't wait for consumers to see. With our strong product portfolio and unparalleled roster of athletes that we have today, we couldn't be more excited about the future of our basketball business. Last quarter, I highlighted another franchise in another sport getting an upgrade, the Mercurial, which added Zoom airbag to create NIKE's fastest football boot ever. And during the exciting World Cup over the last several weeks, the new Mercurial scored more goals than any other boot, led by Kylian Mbappé who won the Golden Boot as the tournament's top scorer. In fact, NIKE's boots dominated the World Cup, scoring more goals than all other brands combined. And consumers have responded to this energy, giving the new Mercurial the highest full price realization of any performance product this quarter globally. And of course, for us, it doesn't just end in innovation with product. NIKE's innovation can also be felt with our rich and powerful storytelling and our deep brand engagement, particularly in global sports moments like the World Cup. NIKE's unique ability to bring together product storytelling in the world's best athletes has once again created something that only NIKE can. As I mentioned earlier, our Q2 results speak to the continued success of our strategy. Consumer Direct Acceleration is fueling our marketplace approach in which we directly connect with the consumer no matter where they shop. Today, our marketplace strategy is driving distinction in this current promotional environment. Our work to directly connect with consumers is founded on a simple consumer insight. Consumers want to get what they want, when they want it and how they want it. And consumers have told us they want a consistent, seamless and premium experience both digitally and physically around mono-brand and multi-brand. And so we're serving consumers digitally with our suite of apps. We're extending our reach and convenience through our strategic wholesale partnerships and leveraging mono-brand doors to fill the gap for underserved opportunities like women's fitness and Jordan. The key is building meaningful direct lifelong relationships with consumers. We deeply believe this will be an important source of differentiation going forward. Why? Well, for one, having a direct connection with consumers avoids the risk of disintermediation. In other words, with the consumer base that comes directly to our apps, to our website and to our owned and partner stores. We, alongside our partners are in a position to control our own destiny. And ultimately, this direct connection enables us to understand consumers better so that we can serve them better with the right assortment, with the right partners and at the right touch points. And what showcases the success of this strategy is our membership base. Membership was a key reason our digital business grew an industry-leading 34% this quarter. Q2 was our biggest member demand quarter ever, and we saw double-digit growth in member engagement. Today, we have roughly 160 million active members who engage with us on a regular basis. And more importantly, our repeat buying members who are more engaged spend more and spend more frequently are growing at an even faster pace of high double digits as they continue to be an important growth engine for our business. And our members also shop seamlessly across the marketplace. In addition to digital, a key member on ramp for us is through our NIKE stores. In fact, more than 50% of store demand comes from members and cross-channel members are even more valuable with higher demand per member than single channel members. An important enabler of giving consumers a personalized shopping experience regardless of channel is our connected membership program with our strategic partners. You've heard us discuss it before, scaling connected membership with DSG, JD Sports, Zalando and TopSports. And today, we're seeing results that are beneficial for everyone. NIKE is already learning more about our members, which helps us elevate in areas such as product creation, line planning and the experiences we deliver. And our partners are telling us that these engaged members are driving improved traffic, conversion and mutual profitability for them as well. And so while it's still early days on this journey, we're excited by the foundation we're creating. The ability to give consumers a personalized experience across channels, fueled by data and insight opens up a whole host of opportunity for us. It positions us to empower consumers with their own choice while keeping the scalability and strengths in digital marketing, product creation, distribution and more, which results from knowing them so well. So ultimately, it will make NIKE a better retailer and also a better wholesale partner. Last but not least, I want to take a moment to acknowledge our Greater China team and the 6% growth they just delivered. As I said earlier, it's been nearly two years of unprecedented disruption in China. But this team's resilience, experience and strategy has set us apart to gain momentum on all fronts. Last month, we had a record-breaking 11.11 consumer moment, which concluded with double-digit demand growth and NIKE having outperformed the industry. And we keep setting new records as part of this important shopping holiday: #1 brand, # 1 in traffic, #1 in live streaming, # 1 flagship store, #1 in membership acquisition and # 1 in member demand penetration. And we're not just #1. This quarter, we saw movement in relative positioning as we create even more competitive separation coming out of this important consumer moment. And as you know, we have remained committed to investing in Greater China for the long term. Even in this dynamic environment, we continue to invest in technology, local marketing and more as we believe the best way to capture demand in China is to serve consumers in a locally relevant way. And today, we're getting a true competitive boost from our investments in these new capabilities. Let me just highlight a few. We launched China-specific versions of our apps to build NIKE experiences that are faster, more engaging and more personalized. We created a first-of-its-kind China-specific member journey with Tmall, which saw a significant uplift in new member recruitment and demand per member. We piloted connected membership with member-linked transactions to 42 NSP stores in 18 cities across China, driving conversion, member acquisition and retaining high-value members. And our team continues to drive China for China capabilities like delivering hyper local product design and localizing marketing content creation. Thanks to this focus, we're now serving our consumers in China with an agile, dynamic and personal way like never before. We're confident in our ability to compete and win in this marketplace for the long term. In the end, I just want to say how proud I am of our entire global team. In times like this, it's people that make the difference. And a great team can turn challenges into opportunities, and we've got a great team, and that is exactly what they have done. This is a group who will stay on the offense to deliver the business while also creating the future of NIKE. We'll continue to build an even stronger position and I couldn't be more excited. Thanks, John, and hello to everyone on the call. NIKE's second quarter of fiscal '23 demonstrated again the power of our portfolio of brands. Throughout the quarter, we leveraged our brand momentum and deepened our connections with consumers to drive strong revenue growth. Before going into our second quarter results and financial outlook, I want to provide more insight on the strong consumer demand that we continue to see and the progress that we have made over the past 90 days regarding our inventory. Consumer demand for our brands drove double-digit currency-neutral revenue growth across NIKE, Jordan and Converse. Within NIKE Direct, retail traffic was up, conversion rates expanded and member buying fueled record digital results. Within wholesale, we saw strong retail sales and market share gains across our top strategic partners. Since last quarter, our brand momentum has accelerated into the holiday season. In North America, our Black Friday and Cyber Week performance set record highs for demand and traffic, fueling strong double-digit revenue growth and exceeding our plan. In EMEA, we closed our biggest Cyber Week ever increasing demand by 75% from last year. In Greater China, our 11.11 demand grew mid-teens, outpacing the sports industry. And globally, our holiday season momentum has continued through the first few weeks of December. Despite operating a largely promotional marketplace, we are creating brand distinction by driving healthy, profitable growth. Full price realization remains strong after strategic pricing increases, especially for our top innovation products in our largest footwear franchises. NIKE Brand ASP is up year-over-year across our geographies, even with higher discounts to liquidate excess inventory. This quarter, we also leveraged targeted promotions to serve and acquire NIKE members, strengthening an important foundation for sustainable growth. Above all, our Q2 results reinforce our confidence that NIKE's brand and business momentum starts with the value that we create for consumers through our product innovation, deep brand connection and elevated experiences across the marketplace. Now let me turn to inventory. Last quarter, we talked specifically about the actions we are taking to address excess inventory, with focus on pockets of seasonally late products, predominantly in apparel. At the end of Q2, we are tracking in line with our plan, and we are pleased with the progress we have made over the last 90 days. Let me go deeper into what we are seeing and why I am optimistic about our path ahead. First, inventory dollars and units are down sequentially. Prior year comparisons are distorted by last year's Vietnam factory closures. But compared to the prior quarter, inventory dollars were down 3% and units are down high single digits, with days in inventory at the lowest level in four quarters. Second, we are making progress where we are focused most. In North America, year-over-year growth in inventory dollars decelerated from 65% in Q1 to 54% in Q2. More importantly, total inventory units are down low double digits from first quarter levels, even as spring product continues to arrive earlier with faster transit times. Third, the composition of our inventory is improving. In North America, apparel inventory units and apparel closeout units are both down mid-teens from the prior quarter. Last, we have proactively reduced forward supply. As I mentioned last quarter, we have tightened our second half buys to prioritize inventory health across the marketplace. As transit times stabilize, we are optimistic that we will begin to see a more normal and predictable flow supply in a more capital-efficient manner. Looking ahead, we are confident that our decisive actions have put us on the right track within the financial parameters that we provided last quarter. Our focus continues to be positioning NIKE for future seasons of sustainable and profitable growth. Now let me turn to our NIKE Inc. second quarter financial results. In Q2, NIKE, Inc. revenue grew 17% and 27% on a currency-neutral basis with strong growth across the portfolio. NIKE Direct grew by 25%, led by 34% growth in NIKE Digital and 11% growth in NIKE stores, highlighted by strong season-to-date holiday results. Wholesale grew by 30%, driven by strong demand for seasonal products, higher shipments based on earlier supply availability and lower shipments in the prior year given supply constraints. Second quarter reported gross margin declined 300 basis points to 42.9%, primarily due to higher markdowns, mainly in North America, unfavorable changes in net foreign currency exchange rates, elevated freight and logistics costs and increased product input costs, partially offset by strategic pricing actions. SG&A grew 10% in Q2, primarily due to wage-related expenses, strategic technology investments, higher NIKE Direct costs and increased demand creation expenses. Our effective tax rate for the quarter was 19.3% compared to 10.9% for the same period last year, primarily due to decreased benefits from stock-based compensation and earnings mix. Second quarter diluted earnings per share was $0.85. Now let's review the operating segment results. In North America, we captured market share, with strong holiday results and positive consumer response to new assortments. Q2 revenue grew 31% on a currency-neutral basis and EBIT grew 21% on a reported basis. NIKE Direct grew 23%, with NIKE Digital up 31% on double-digit growth in traffic and repeat member buying. Wholesale revenue grew 37%, driven by strong marketplace partner demand and improved inventory supply. Performance innovation and fresh seasonal product resonated deeply with consumers. The LeBron 20, KD and Giannis fueled double-digit growth in basketball. And the AJ11’s Varsity Red shock drop highlighted Jordan Brand’s momentum. In women's, our new statement leggings, NIKE Girl, launched with positive early response as the Free Metcon grew double digits. Dunk outperformed in men's, and Pegasus continues to win with everyday runners. Beyond product innovation, NIKE continues to create distinction at the intersection of culture and community. Ahead of homecoming season, our Yardrunners campaign elevated the voices of HBCU changemakers alongside the release of co-created product through our SNKRS App and neighborhood partners. In addition, with the recent announcement of future Nike x Off-White collections, we are deeply honored to introduce the next chapter of Virgil Abloh’s continuing legacy with NIKE. In EMEA, our team landed yet another strong quarter. Q2 revenue grew 33% on a currency neutral basis and EBIT grew 23% on a reported basis. NIKE Direct grew 44% on a currency-neutral basis with NIKE Digital growing 62%. Membership was an accelerator as members drove over 85% of demand during Cyber Week, our highest demand week ever in EMEA. Our campaign led with sport, adding more than 1 million new NIKE members as we invited consumers to join us in celebrating the World Cup. The power of our portfolio drove momentum across the marketplace. Earlier this month, we celebrated the Milan opening of Jordan World of Flight, a premium retail concept at the forefront of basketball culture. Meanwhile, NIKE dominated shoe and apparel accounts at the Berlin and London marathons, as Alphafly drove strong sell-through. Pegasus Shield and Winflo Shield grew double digits in women's running. Zegama created energy in trail running, the sport's fastest-growing segment and Global Football grew double digits as we continue to celebrate an incredible year of sports. In Greater China, our brand and business momentum continued as Q2 revenue grew 6% on a currency-neutral basis and EBIT declined 10% on a reported basis. NIKE Direct grew 4% on a currency-neutral basis, with NIKE Digital growing 9%. In addition to delivering positive growth, we achieved our goal of returning to inventory health at the end of Q2. Inventory dollars declined 3% this quarter and close out inventory was down high double digits versus the prior year, with closeout mix now in line with pre-pandemic levels. Our team delivered these results while managing through significant COVID-related disruption, including the closure of over 1,500 owned and partner stores at the end of November. We continue to closely monitor ongoing risk while focusing on what we can control, deepening our connections with Chinese consumers. As 18,000 runners joined in the return of the Shanghai Marathon, our brand presence was deeply felt, not only as the title sponsor, but also as NIKE dominated the shoe count and local NIKE athlete, Zhang Deshun, topped the podium. The energy extended into double-digit growth through our running business led by Zoom Fly and Vaporfly as well as the Pegasus and Winflo. NIKE's brand momentum with our youngest Chinese consumers continues to grow as well. On 11.11, Gen Z demand for NIKE grew by 45% on Tmall. And with NIKE leading on 11.11 as the #1 store on Tmall's Kids footwear channel, plus our top kids lifestyle footwear franchises growing double digits in Q2, we are more excited than ever about NIKE's opportunity to serve the next generation. Finally, in APLA, our team continues to over-deliver in our fastest-growing, most diverse geography. Q2 revenue grew 34% on a currency-neutral basis, and EBIT grew 25% on a reported basis despite the transition of our SOCO territory to a distributor model. NIKE Direct grew 30% on a currency-neutral basis and NIKE Digital grew 35%. We deepened consumer connections across territories with member days fueling robust growth. In Korea, one of our fast-growing marketplaces, we're excited to integrate our digital business on to NIKE's global platform, which will enable us to serve Korean consumers through the NIKE and SNKRS App. We also continue to strengthen local connections through our Express Lane with launches such as our Somos Familia collection. Across APLA, this quarter showed the power of our complete offense. In women's, we drove energy in lifestyle with local storytelling around the Air Force 1's 40th anniversary. Global Football and Running led the way in men's performance, and Kids delivered balanced growth across apparel and footwear. Finally, the Jordan brand continues to be an incredible engine for growth with momentum in streetwear and performance footwear. Now I will turn to our financial outlook. As I said last quarter, we are taking a measured approach in the second half against an uncertain macro outlook as we continue to prioritize a healthy pull market. That said, we remain positive regarding the strong consumer demand we see across our portfolio of brands as well as the health of our product franchises. From product innovation to rich storytelling, the value that NIKE creates for the consumer continues to drive business momentum and competitive separation across the marketplace. Given our strong second quarter performance, we now expect full year revenue to grow low teens on a currency-neutral basis, an improvement from our low double-digit guidance in the prior quarter. As of today, we expect approximately 700 basis points of foreign exchange headwinds, resulting in full year reported revenue growth of mid-single digits. Third quarter revenue growth is expected to be higher than the fourth quarter due to timing of wholesale shipments. We continue to expect gross margin to decline between 200 basis points to 250 basis points versus the prior year, reflecting ongoing liquidation actions in the second half. This outlook reflects our strong performance in Q2, mostly offset by an additional 25 basis points of negative foreign exchange impact, now totaling 95 basis points for the full year. We expect the third quarter gross margin will decline at a similar rate as the second quarter, including 120 basis points of foreign exchange headwinds. For the full year, we continue to expect SG&A to increase high single digits. We expect third quarter SG&A dollars to be in line with the second quarter. And we now expect our effective tax rate to be in the high teens range, primarily due to decreased benefits from stock-based compensation. As many of you know, we closed out NIKE's 50th anniversary this year. And for all the history NIKE has already made, it's the future that inspires us most. After all, NIKE's culture of innovation doesn't just shape the products we create and the stories we tell. It also defines the way we adapt and accelerate through dynamic conditions. Over this past year, no matter what we have faced, our teammates have continued to come together and deliver. I could not be more proud of their efforts. And as we turn toward NIKE's next 50 years, I have every confidence in the future this team will create. To every member of our NIKE Jordan and Converse team around the world, thank you for all that you do and happy holidays. I'm hoping you can help with more insights on the composition of growth in North America and where you stand with clearance efforts. I believe, Matt, you said ASP was up in all geographies. Is that true for North America as well? And then looking at the split between footwear and apparel growth: footwear, very strong acceleration; apparel, more modest despite what I would have expected clearance efforts. Can you just speak to where you stand with respect to moving to those apparel balances? Sure, Jim. We saw strong growth in the North America marketplace, up 31%. And really, as you noted, it was really strong across channels, NIKE Direct and our wholesale partners as well as across gender. Our Jordan brand delivered incredibly strong growth in the quarter as well as our footwear business. Yes, our ASPs overall for the geography were up. That was definitely benefited by strong performance in our footwear business. I mentioned our strong demand that we saw over the holiday season. And in particular, the consumer moments right at the end of the quarter. But throughout the entire quarter, we continue to see strong levels of full price realization in footwear, which continue to give us confidence in our most important product franchises, the stories that we continue to tell to refresh and make them relevant as well as the new products that we continue to bring to market on a seasonal basis. Specifically to your question about inventory and our actions there in North America, I referenced that we saw our units down versus Q1 levels, low double digits. And our focus in the quarter was really around our apparel liquidation as well as managing apparel closeouts. And both those dimensions were down mid-teens from a unit perspective versus the prior quarter. We continue to see strong demand from our value partners on the wholesale side for our out-of-season apparel. And we continue to be very confident in our ability to continue that liquidation through the balance of this fiscal year. I guess just on the inventory, Matt, is there a number, as you think through the next few quarters, could you give us an idea of where you think you'll land in terms of the inventory levels or when you might sort of have a more normalized number either in North America or overall? Sure, Bob. Well, as I mentioned, we are really pleased with the progress that we delivered this quarter and where we ended Q2 is in line with the plans that we set 90 days ago. I guess the first thing I'd say is our prior year comparisons on inventory are really distorting the progress that we made this quarter because a year ago, we were undergoing 15 weeks of lost production capacity from our factories being closed in Vietnam. And so, it depressed the base quite significantly. When we look at the progress that we made this quarter where we needed to focus most, we feel really good about the momentum that we have there. And when we look at the brand momentum that we had into the holiday season and into the holiday season and where our partners are at, we continue to be confident in the momentum that we're building there, especially in the pockets of inventory that were elevated as a result of what transpired last quarter. I'll tell you two other things. As we look at transit times continuing to improve, one of the things that gives us greater confidence is a more predictable flow of supply on normal lead times. If you recall what we've been navigating over the past two years, it's been pretty significant and volatile, and it continues to increase our confidence levels. But we're focused on prioritizing healthy pull markets going into fiscal year '24. And so we expect the spread of inventory growth to revenue growth to continue to narrow over the second half. We already showed strong improvement this quarter, but we expect that spread to continue to narrow in the second half, and that will be driven based on strong demand and also the buy tightening that we did for the second half last quarter. Thanks, and congrats on a nice quarter. So maybe for John, two strict quarters of double-digit accelerating constant currency revenue growth. I guess, can you speak to the level of brand heat for NIKE that you're seeing in the marketplace today? Maybe elaborate, Matt, I think you cited market share gains that you're seeing in North America. And then just what's your confidence in sustaining this kind of momentum as we think about your product pipeline moving forward? Yes. Sure, Matt. The -- one of the refrains we've been using repeatedly, frankly, for the last 2.5 years is in times of turbulence, strong brands can get stronger, and that is our ultimate -- that's our ultimate goal, which is whatever challenges or opportunities get faced by everyone, we want to make sure that we capitalize better than others and get stronger and gain share. And that's what you're seeing through the last couple of quarters, and we believe continuing in the next several quarters. And frankly, the fundamentals are simply leveraging our competitive advantages. It's that sort of unique NIKE combination of great product, product innovation, like the Mercurial or combined with great roster of athletes and teams with great storytelling that you really bring to life in moments like the Euro chance for women's last summer and Men's World Cup this year, combined with distribution where we're getting consumers what we want, when they want, how they want it. And so it's that combination that certainly -- and as we come out of more and more COVID, we're being able to pull together time and time again, the LeBron 20, another great example, great product, great storytelling. I hope everyone enjoyed those commercials with a great athlete, and that sold through throughout the globe very, very quickly. And if there's one dimension that I would say is kind of a fourth source of competitive advantage from our historical ones, it's this digital advantage. And it's -- you see we grew digital 34% in an e-commerce -- global e-commerce market that most people would say is low single digits. And that is where having the direct connection with consumers, having the best apps in the industry allows us to leverage the full funnel of membership base. And we believe that's going to be an important fourth source of competitive advantage throughout the globe, and that will continue for quarters and years to come. So we're staying focused on the fundamentals to be honest. And with the strong mantras let's make sure we get stronger and create greater competitive separation regardless of what the environment throws us. Yes. And I just would say on the comment about market share and confidence, really, you saw the balanced growth we delivered this quarter across channels. And as John mentioned, it really does start with digital with that 34% growth. But I wouldn't want you to miss the importance of the funnel and the way that we're converting active members to buying members and increasing member buying frequency because our growth in actually over-indexed our overall digital growth, really referencing that, that strength of the consumer coming in. From a wholesale standpoint, the momentum that we're seeing is strong retail sales from our wholesale partners to consumers. But you'll recall that we've been starving the wholesale channel for six to eight quarters because of supply constraints. And so as we had supply constraints, we were prioritizing adequate inventory levels within NIKE Direct. And so we're seeing strong demand as we go back into our wholesale partners with available supply. That's enabling us to increase our open to buy in that channel. And as inventory supply becomes available on a greater basis than it was, we continue to see our partners pulling on the available inventory. So we're competing in that channel. There it's an important channel for us to lean in. And really for the first time in six quarters or so, we can finally supply the channel against the level of demand that we believe is there. This is Brooke Roach filling in for Kate. John, I wanted to ask you a little bit about what you think the next phase of the membership journey for NIKE would look like following the success that's achieved with that program to date? And then perhaps in the near term, how much of the strength of NIKE Digital that you're seeing today is due to underlying full price selling? And how much of that may be driven by increased depth of promotions, driving the consumer to convert at a higher rate? Well, on membership, the way we think about membership is along the full funnel. And so the first thing I'll say about that I think is a really important dimension of membership is membership is no longer just something that happens in NIKE channels. Having connected membership with our strategic wholesale partners now allows the consumer to have a member experience regardless of where they shop and allows our wholesale partners to have the same advantages that we have by knowing who the consumer is, what they’ve bought and being able to serve them in a more personalized way. And so I would say we're still in the relative early innings of what we believe we can do on the membership on the membership front. We have 160 million active members. We're working on engaging them more frequently, whether it's through NIKE Training Club, NIKE Run Club, the SNKRS App where it's more than just what they buy, but it's their engagement. We think there's a lot of content that we can be bringing to those members and you're going to see some, I think, interesting announcements in the coming weeks about partnerships and things we're doing to drive engagement across NIKE members. And then down to the bottom of the funnel, it's making sure we're getting them as I say repeatedly what they want, when they want it, how they want it, knowing what products they want, making sure they have the best possible experiences making sure that repeat buying is made easy and convenient. I would say the supply chain dimensions and what we've been doing with our membership is just phenomenal, having gone from 10% digital to 27% delivering fast delivery times, fewer reduced and split shipments. And so it's really kind of a holistic approach, and we're going to just keep leveraging that and keep building upon that. As I said, I think we're in the roll days. And then our digital growth, I think, is a function of having the best apps in the industry or on the home screen of people's mobile apps, which is that scarce and valuable real estate. And we have a really clean experience across our apps and digitally, including NIKE.com. So there's -- we have good full price realization, and when need to move things, we move it through discounting. And so it's obviously very fair product category and varies by time. But the quality of the business through NIKE Digital is among the highest quality that we have across any channel. Yes. When you compare this quarter to last year, our inventory supply was so lean that last year, we saw extraordinary levels full price realization through our digital channel and the lowest levels of discounts that we've ever experienced in running that channel. So we expected that to normalize in this fiscal year. And with where inventory is broadly across the marketplace, the environment is definitely more promotional. But as John mentioned, when we look at our most important product franchises, we continue to see strong full price realization in our own channels and in wholesale. And I'd say that the other thing that we focused on this quarter was leveraging our investment in markdown to drive new member acquisition and to increase loyalty from our existing members, and we were able to accomplish that this quarter. I wanted to ask about China. So obviously, returning to growth in a pretty challenging environment is fairly encouraging. How do we think about the path forward in China from here? I know you mentioned that inventory is much cleaner in China now. So should we think that you're kind of back to a pull market in China? You should be able to sort of build off the momentum you've had this quarter. Just how do we kind of think about the path forward in China from here? Yes, Tom, well, maybe I'll take a piece of it and then, Matt, you can comment as well because it's such an important topic. You heard both of us talk about that given all the short medium-term challenges, we are very pleased with the results in China this quarter. And the thing that we've been really focused on is the consumer, the Chinese consumer and their connection to the NIKE, Jordan and Converse brands. And the 11.11 holiday was one that we focused on a lot because it's really, in many ways, the first time in over two years that we could fully compete. We had the supply of the right product, including some of our hottest global and local product. We had a full local marketing capability going full stream, and we had our kind of entire offense. And the results of the 11.11 holiday were quite strong, both versus what our plan was and versus competition. We had mid-teens growth overall. We've been very focused on youth in China, the young consumer, both kids and Gen Z. You heard Matt say, our Gen Z grew 45% in demand on Tmall through 11.11. And as I said in my script, we're #1 in traffic and brand and flagship and member acquisition. And the quality of that growth is quite strong underneath it. When you look at the Jordan brand, you look at I mentioned LeBron 20, great full price realization. So we felt very about the consumer fully back with NIKE, with Jordan, our ability to compete with both global and local competition. And we take that into the coming quarters. Yes. And I just would comment on inventory. We set a goal two quarters ago to be clean by the end of the second quarter, and we reduced our buys and we focused on moving through the excess inventory that we had. And so we're incredibly pleased with the results that our team has delivered through the end of this quarter. We think it puts us in a position of strength relative to the marketplace to be clean and to be ready to face whatever uncertainties are in front of us. I obviously mentioned that we had 1,500 of our stores closed in the last week of November. That was roughly 5x the number of stores that were closed on average throughout the entire quarter. And we also saw traffic impacts as the country navigates through this transition of its COVID policy. So we've taken a very cautious approach in our guidance to China, given the short-term uncertainties that are there. But what you should be hearing from us is a consistent trend of confidence and encouragement in the consumer connections that we're creating that give us confidence in the long term. Good afternoon and congratulations, really a nice amazing quarter. My question is on Greater China. Obviously, this is the first quarter we're now starting to see that constant currency growth. So very happy to see that inflection. What have you seen sort of after the quarter as things have opened up even more sort of in the December timeframe? And does it give you any -- do you have any more kind of solid thoughts on sort of what the growth algorithm could look like, maybe 2023 and beyond or it’s still very much too early? Last question is, when does that Shenzhen tech center -- I believe is it open now and when is it starting to put forth that China-specific product? Sure, Adrienne. On your first question, I think I answered it in the last question. But as it relates to our performance this quarter and how we're planning for the second half of this year. We've obviously been measuring the China marketplace very carefully given the COVID-related disruptions that we've been experiencing. We've sort of gone from one policy in terms of the way that the marketplace is being managed and to control the spread of the virus to this new approach. And I referenced the door closures that we saw at the end of the quarter. As it relates to our guidance and our expectations, I guess what I can say is that we're taking a very careful approach. We have a lot of empathy for the consumers in terms of what they're going through in that environment. And we're watching traffic closely. But having inventory cleaned at the end of the second quarter really gives us a position of strength to deal with whatever uncertainties that are in front of us. As far as the longer term goes, it's a little bit too early to tell, except we continue to think about the encouraging signs that we're seeing from a consumer perspective. And as John mentioned, 11.11 was really one of the first moments in several years that we felt like we were able to align the complete offense up in order to be able to engage across products -- product engines, gender and brands. And we saw very strong consumer response. And so when we look at the underlying macro drivers long term of the consumer interest in sport health in Greater China, we continue to view it as a growth driver for our business long term. So looking at the strength in wholesale, I know you said there was better inventory availability to ship to those wholesale channels. But can you just talk about how you're viewing the wholesale channel considering your direct strategy? And with that growth, did you enter or reenter any new doors? Or was this growth mainly within those current partners you've already talked about? Yes. Abbie, the strategy remains very much the same. And as I mentioned repeatedly, it's consumer driven. It is consumers in this day and age want to get what they want, when they want, how they want it and they want a consistent and seamless experience from us. The same consumer shop online and offline, the same consumer shop mono-brand and multi-brand through different occasions. And so our whole strategy is to offer them that choice in a seamless and premium way. And then wholesale plays a very important part of that, right? It provides a very strong footprint, both physical footprint as well as digital. And we mentioned last quarter, we had our wholesale partners on campus in September for the first time in three years and exposed them to our product innovation pipeline and just talked about how working together, we can really serve that consumer through connected membership. And those conversations have just gone great. For instance, this quarter, we spent a lot of time with Mary Dillon and her team at Foot Locker talking about how the next phase of growth for us can jointly be great around real opportunities of basketball and sneaker culture and kids. And so there's a lot of excitement, I would say, with our wholesale partners and what we can accomplish together and particularly through a connected membership environment, which allows us to serve our mutual consumers in a better way. Yes. And I would just say that from a revenue growth perspective, we think this quarter was clearly a peak in terms of year-over-year revenue growth in the channel. And that's primarily driven by timing implications. There's the prior year comparison because we were low on available inventory for the wholesale channel, which depressed our growth in the prior year. And secondly, because we're seeing current season product becoming available earlier, we saw a stronger pull of shipments from Q3 into Q2 into our revenue growth this quarter. And I think that's indicative of the demand that we're seeing and the strong sell-through that we're seeing through to the consumer. So we continue to view this channel as being a channel that will drive growth. But for the balance of this year, the comparisons are going to be difficult to understand when compared to the prior year due to the supply constraints we had in the prior year. Excellent. Congrats on a nice quarter and the acceleration. Just, Matt, as we look at the constant currency revenue guidance implied for the back half of the year, it does assume a bit of a deceleration. Just talk about some of the assumptions regarding the macro? And is there a level of conservatism as you look at the back half of the year. Sure, John. Well, first, I'd say we raised our guidance to low teens on a currency-neutral basis, really reflecting the accelerating brand momentum that we saw in August carrying through back-to-school into September and then accelerating through the holiday season and even the first couple of weeks of December. And so we do have confidence as we're looking in the near term that the consumer continues to be uniquely interested in NIKE, Jordan and Converse, and it's fueling our growth. What I said last quarter is still true, though, which is that we were concerned about the macro uncertainty and the indicators that we're seeing more broadly for the consumer. And while over the last 90 days, we've seen strength. Those macro concerns have not abated. They're still there for the consumer. And so we continue to take a cautious approach to the second half. We buy our inventory, as you know, on six-month lead times. And so we took some decisions in light of the inventory -- our inventory position at the end of Q1 to reduce our buys for the second half of the year. And we focus those reductions in places where we had excess inventory, but we preserve the strength of our product franchises and the new innovation that John referenced earlier in the call that's going to be coming to market in the second half and in the beginning of '23. So we continue to take a cautious approach as we look at it. And to the extent that consumer demand continues to be strong, with a supply chain that's providing product in a more predictable manner, in a more timely manner, if we ended up overcorrecting on our buys, then we will chase demand as we exit this year and enter into fiscal year '24. And ladies and gentlemen, we have time for one further question this afternoon, and we'll take that from Michael Binetti at Credit Suisse. Congrats on a great quarter. I know it's a lot of heavy lifting. It may be a simple question, but how do you feel on North America inventory in the channel? I know you moved the mountain, but you have a big wholesale business is hard for us to track inventory once it leaves your books. Are we past the peak promotions in the U.S.? Is this the highest level of promotions in your view? It would seem so based on some of the inventory comments you gave on the U.S., I just wanted to check that. And then I guess as you start to come out of some of the recent volatility, maybe you can help us connect back to your longer-term targets, in particular, the path to the high teens EBIT margins and the major input to getting there, the D2C versus wholesale transition since we don't get many numbers reported on the margins between those two channels. How would you tell us to think about building our understanding into how you get there from here is that seems like the next part of the NIKE story? Sure, Michael. Well, as it relates to North America and the marketplace, we're seeing the momentum from a consumer perspective, building across both channels over this holiday season. So yes, promotional activity is higher than it was in the prior year. But we do see strong full price sales in footwear and in our seasonal inventory, and we see more promotional activity in areas that are -- where inventory has built and/or there's just broader inventory availability in the marketplace. I think our focus continues to be in this environment on prioritizing our brand getting to a healthy inventory position by the end of this fiscal year with why we've taken more aggressive action. But I think we've been pleased at seeing the year-over-year ASP growth, not just in North America but across all our geographies and high levels of full price realization in the areas where our consumers are most interested, and it's hard to get access to the products that they desire, which means that from a brand health perspective, even amidst the promotion, the consumer continues to choose NIKE. As it relates to your question about the long-term margins, I guess the way that I think about it is we have structural drivers of profitability, and we have transitory impacts that we've been dealing with since fiscal '21. At this point in time, the transitory impacts roughly equate to about 350 basis points of gross margin pressure, which directly drops to the EBIT margin. And those specifically relate to two successive years of elevated transit and freight costs; and then secondarily, the cost to liquidate some of the excess inventory in North America. And we do expect those to be transient or transitory. We should expect to start to see some recovery in fiscal year '24. We will give more detailed guidance on that in our normal course. But those, we do believe are recoverable. From a structural side, we have the same structural drivers that we've always had from a profitability perspective, and we continue to be focused on them. It starts with price value of our products and how we create value for consumers and the products that we make. You saw that we increased prices by mid-single digits this quarter, and we continue to see that so long as the product is valued by the consumer, we've been able to stick those price increases in order to help offset growing input costs, there's cost initiatives in our FOBs that we're focused on. We have the shift towards NIKE Direct. This quarter, that didn't drive any benefit because we saw strong wholesale growth, but we do expect to see a benefit from a structural perspective as we continue to drive accelerated growth in NIKE Direct through our stores and through digital. We continue to focus on supply chain efficiency opportunities and then continuing to drive higher full price realization across the marketplace through better capabilities in demand and supply planning. So those structural drivers we continue to believe are going to be accelerants for us. But given the size of the transitory impacts that we've dealt with over the past two years, it's really important that we drive focus and attention on recovery of some of those elements. And trust me, our teams are focused on it, and we believe those will be value drivers for us in the near term. All right. Thank you, Michael, for the question and everyone who was able to join in and participate in this call. We look forward to speaking with you next quarter. Happy holidays. Thank you, gentlemen. Again, that will conclude NIKE Inc.'s fiscal 2023 Second Quarter Conference Call. We'd like to thank you all so much for joining us and wish you all a great evening. Goodbye.
EarningCall_1422
Good morning. My name is Doug, and I will be your conference operator today. At this time, I would like to welcome everyone to the Park Aerospace Corp. Third Quarter Fiscal Year '23 Earnings Release Conference Call and Investor Presentation [Operator Instructions]. At this time, I would like to turn today's call over to Mr. Brian Shore, Chairman and Chief Executive Officer. Mr. Shore, you may begin your conference. With me, as usual, as always, Matt Farabaugh, our CFO. So we announced our earnings this morning. In the earnings announcement there also are instructions as how to access the presentation, either view our webcast or through our website, you want to have that up in front of you to make the call more meaningful of course. Just one note, I don't want you to freak out too much about the length of the presentation. I think it's like 55 slides. But what we did is we incorporated a number of slides from the prior presentation, Q2 and even Q1 for context and perspective. So the third quarter presentation stands on its own. You have to go back and start, check in the second quarter or first quarter presentation to get the full picture. But those items that we just -- that we carried over, pretty much intact. We'll probably skip over at least skim over. So it's a lot of slides, but I think we'll be able to move through it relatively quickly. And when I say that, it's probably 45 minutes, but it's not going to -- we're not going to go through every slide to cover that. So of course, when we're done going to go through the presentation, Matt and I will be happy to answer your questions. And I think that's it. So why don't we get started. Here we go. So let's move on to Slide 2, our forward-looking disclaimer language. If you have any questions about that language, please let us know. Slide 3 is our table content. The presentation that we're about to go through and then the supplementary financial information, that's Appendix 1. We're not going to go through that either during the presentation. But if you have questions about it, please let us know, of course. Slide 4, we will slowdown a little bit for Slide 4. This is the earnings results, at least high level. If you look at the right-hand column, these are quarterly results, of course. And highlighted in yellow, we have Q3 sales, $13.867 million. Gross profit, easy number to remember, $4.444 million. Gross margin, 32%, which we like to be higher. But as we always said, we get real unhappy when it gets going below 30%. If you look at Q2, it actually did go below 30%. And we have a couple of quarters where it's gone below 30%. Now you go back to the fiscal year '21 and that was the beginning of pandemic. So we know a number of quarters where the margins were lower. So adjusted EBITDA, $3.321 million, EBITDA percentage 29.3% [ph]. What do we say about Q2, during our sorry -- what did we say about Q3, the current quarter during our Q2 investor call, what did we say about it? We said our sales estimate was $13.25 million to $13.75 million. So we came in just a little tad above the top of the range there. And then our adjusted EBITDA estimate $3 million to $3.5 million. The adjusted EBITDA, as I said is $3.321 million, so kind of in the middle of the range for EBITDA. I'll just remind you briefly about our forecast philosophy. We tend to kind of remind you almost every quarter our forecast philosophy, when we give you a forecast, we're saying to you, this is what we think will happen. We don't play what we consider to be a game of giving you a low number that we can beat and then be heroes. That's not what we're doing. And our employees, they have the same targets. So these are real objectives for us. And they're not easy objectives. These are again, we're telling you what we think will happen, assuming that we do what we normally do, is work very hard to make the numbers. So I just want to mention that to you. So when we make our numbers, the fact that we gave you a number that was in our forecast, the prior quarter that was low, so it was beat to call, I guess in Wall Street. That's not something -- we think it's just kind of a waste of your time and our time to play that game. The other thing is that we have -- when people do that, I know most people do, to us they're not really being honest with you. They tell you this is what they think is going to happen. They don't really believe it. And that's not for us. So we're not judging others. We're just telling you, reminding you of our philosophy. Let's go on to Slide 5. An outstanding job by Park's people to exceed by just a little bit our Q3 sales estimate and to make our Q3 EBITDA estimate, especially considering significant challenges with supply chain disruptions, freight disruptions, unreliability, staffing shortages. It was not easy to make those numbers. And total missed shipments in Q3, approximately $650,000. We're still struggling with these things. Those three checked items are the reason for the missed shipments in Q3 that hopefully will carry over to Q4. Factors which affected our margins in Q3. So we're going to go into the next page, is a bunch of factors, a number of factors we'll be talking about. So far, we're talking about top line in terms of how much we -- the $650,000 we missed top line. Now let's talk about bottom line. Let's go on to Slide 6. Significant inflation. That's not going away or abated yet, not for us anyway. Raw material costs, shipping supplies, other supplies, utilities, freight in, freight out, people costs, you name it, probably more expensive. Some of the increased costs were passed through to our customers in Q3 and form of selling price increases, but not all. Why is that? First item is the lag effect. And so we honor our commitments on our POs. Some companies don't do that. Some of our suppliers surprisingly haven't done that. We're going to confirm PO and then we're going to go ahead and confirm that PO with our customer based upon the expectation of raw material costs. And in the middle of the process, we are told that our cost is going up, even though there's a PO that we have from our supplier. So we get burned with that. But we don't do that. We live up to our commitment -- it's not even a discussion, it's not a great area. We make a commitment, we live up to it. So there's a lag effect. So we need to wait until the next time we quote this customer in order to take into account the increased costs. And the other thing is, forget about our suppliers for a second, just the other costs are going up. They haven't gone up very quickly. And people talk about inflation moderating. We don't see that. Sometimes it's hard to keep up. We anticipate a little inflation when we do our quoting, but sometimes it gets away from us. So we get behind the power curve. But we just -- we live up to our commitments. So that's a lag effect. We'll wait until the next time we quote in order to take into account the inflation factors. And then the other factor is LTA pricing with certain customers like that big one MRAS which we talk about a lot of these presentations. We have long-term pricing, fixed pricing. It could be subject to fixed adjustments, but it's not often based upon inflation factors. So that's also an issue. And inflation is really a burden for us. It's really becoming a burden for us. And our people, I think, are doing a pretty special job is finding ways to overcome that burden because there's a real burden. It's not just kind of a rounding error kind of burden. It's a real burden and it's something that we live with every day. And we continue to live with. We are not sure when it's going to go away. Like I said, people say it's moderating. We don't see it in our little world. Let's go on to Slide 7. Still talking about margins, what happened -- not what happened on our margins, but things that impacted our margins, let's put it that way. Somewhat lower margin product mix in Q3 than expected. So why did we not fully anticipate this in our planning? When we gave you a forecast for Q3 back when we did our Q2 announcement, why don't we anticipate the product mix? And my comment is, I think the same comment we gave you last time, planning is interesting in the world of supply chain chaos. So we have a nice plan. It's great. But so we put the plan in the drawer, then the chaos happens because of supply chain disruptions and freight disruptions. Whatever we plan is nice, but it's not what we're able to do. We have to shuffle. We have to move things around. We have to scramble. We have to make things happen. That's the Herculean effort that's involved to make our numbers, to make our quarters because if we just kind of went as planned, they would not work out too well. And then Mike Tyson, everyone who has -- everyone has a plan so they can punch them out. I think it speaks to us, because we have a plan, but almost immediately after the plan is put in the drawer, the world changes on us and a lot. This is not normal. I mean, things always change a little bit, but changed on us a lot. So it's very difficult to anticipate exactly what we're going to sell in any quarter and that's why it is difficult to anticipate the product mix exactly in terms of margins. What we plan is good, but we end up actually selling during the quarter may not be what we planned. And in fact, it has been up in what we planned. Supply chain disruptions continue to cause significant efficiencies in our manufacturing operations. If you know people that run the manufacturing operations, one of the things they really like the best is to be building to plan the manufacturing operation with some kind of predictability. And when you have to scramble and adjust and move things around, it makes the manufacturing operation very inefficient. Again, this is another thing that our people had overcome. They did an outstanding job in my opinion of overcoming it. But at the end of the day, notwithstanding all the obstacles, challenges and difficulties our great Park people pulled together to get the job done to make our Q3 numbers. Each person, each Park person received a quarterly bonus, our Q3 quarterly bonus of $200, not in thousands. They didn't get $200,000, they got $200 for his or her outstanding job under very challenging circumstances. Let's continue to Slide 8. Slide 8, we won't discuss very much, but this is a slide that we provide in our presentations for historical context and reference. Any questions about the annual -- historical annual results, let us know. Let's go on to Slide 9, just to save a little time here. Park's balance sheet, cash, cash dividend history and recent share buyback authorization. We'll skip through some of this stuff. One of our key investors recommended we cover it to me. We cover this every quarter. I thought it was a good idea. So we're doing that. Some of the stuff is not that newsy. It's kind of going over things we covered before. Let's see our reported cash was $103.3 million in Q3. What's our investment philosophy? We invest in highly secure liquid securities, such as treasuries, governments, high-grade commercial paper. We don't take any credit risk. We do take interest rate risk because look our average maturity is 21 months. So interest rates spiking up, you don't have, because that means the value of the investment at least, temporarily ends up going down. Our practice, by the way, is to hold our investment to maturity, but the value of them on accrued basis is going to be depressed if interest rates are going up, which they happen, of course. We report this is how reporting is done mark-to-market. So it's not the investment value, it's the market value of our securities and investments that are reported to you with that $103.3 million. Just so you know, in case I put it that way, the amortized cost basis of our cash and marketable securities as of the end of Q3 was $109.2 million. I just want you to have that information and you figure out, you decide what you think is a more relevant number. If we hold these securities to maturity, which has been our practice, we'd probably get closer to about $109 million. When these securities mature, you got a 21-month average maturity, but the present value of $103.3 million. The other reason I want you to know that is in case you're wondering, what happen to our cash, well, it's like the cash has been -- we're not spending the cash recklessly. The value of the cash for reporting purposes is affected by interest rates. Again, we don't take any credit risk. We just take interest rate risk. So we have an average of 21 months, and that means we're exposed to interest rate fluctuations. Let's go on to Slide 10. Any more questions about that, please call Matt later and ask them because that's about as much as I can explain about how we report our cash. Slide 10. We've got about maybe $13 million of spend on, especially the installment tax payments. So again we'd like to share that with you because if you're thinking about how much cash does Park really have, that's relevant. This is a liability we have. It's on our books, but we still have to pay the IRS over the next three years or something like that, that $12.6 million. Cash dividends, every quarter we cover this. Let's go to the last check item. Park has paid $558 million now in cash dividends since the beginning of 2005. And I'll give you my comment that I always give you, which is that that's a hell a lot of money for a small company like Park, $558 million cash dividend. Let's go on to Slide 11. Share repurchase authorization. This has been kind of a hot topic of late. We announced in May 23, 2022 that our Board authorized a purchase of 1.5 million shares of companies -- of our Park stock, common stock. And did we purchase anything in Q3? No, we didn't purchase anything but not for not trying. So maybe the market was making us an offer that we couldn't refuse. Well, we've been in blackout since middle of November, but during the Q3 period where we were not in the blackout, remember, stock went down to like, I don't know, $10.11 or something like that. It was trading in the tens for a little while than they have. At that point, we felt the market might be making us an offer we couldn't refuse. I told you the last time, we don't think it's our job to buy stock. We think it's your job to buy stock, your job to decide whether you want to buy stock or not. We don't think it's really our principal job. Our principal job is what? Do everything within our power to enhance the fundamental value of the company. That's what we're working every day. We're not market traders. So we're not too excited about buying 5,000 or 10,000 shares a day. It seems kind of like suddenly you waste your time in petty. But when the stock was tuned to that level, we felt maybe the market was making an offer we couldn't refuse. Worked through an [ph] amount of buyback. They're doing a great job. If you ever know somebody who wants to do a buyback program I'd recommend them without reservation. And we were looking for blocks and big ones, but we didn't find anything. And we're told that the institutions are more really all buyers, not sellers. So we couldn't find anything. And then if you remember, the stock started to move away from us up to $11, $12, $13, $14. At that point we backed out because we don't want to compete against actual outside buyers who are buying the stock. I just want you to know that I'm not saying the price here. We're not saying that the price goes down to $10.5 we will be back in the market. That's for us to know, and you not to know this. That's -- we will discuss what we will do in the future. I just want to give you the facts as to what happened in the past, all right? So for your perspective. Last item with interest rates rising, era of cheap and easy money coming to an end, we hope with Park's hard-earned money finally would be worth something, maybe we hope so. Let's go on item, Slide 12, rather. This is -- we cover this every quarter. Let's just go through it. AAE Aerospace. That's the MK125 warhead with a standard missile 2, SM 2. That's a really nice program. I like being on that program. Let's see in the next Kratos Defense, well, you can see the Kratos Valkyrie. We're really very pleased being in that program. It's a really exciting program. We love working with Kratos also. And I don't know if you saw it, but just recently announced that they did a new deal with Kratos with the navy for a couple of Valkyrie aircraft. So that's exciting for us anyway. Lockheed Martin, well, that's secret program. We're not allowed to talk about it. So we can't give you pictures or anything else. But they are in the top 5. So we can tell you they were top 5 in Q3, and that's what we can tell you with that. And Middle River, yes, we know who they are, MRAS, we call them. And that's the like the Comac 919 with the LEAP-1C engines. And then Nordam, bottom right, the Bombardier Global 8000 with the Passport 20 engines. Actually, MRAS is on that program as well as Nordam, but we're choosing to focus on Nordam this time for the Bombardier Global 8000. Let's keep going. Slide 13, our pie charts. I guess what I would high level of interest is if you look at fiscal '22 and fiscal '23 first nine months, boy, it sure looks the same, doesn't it, hardly any change at all. I mean commercial is actually the exact same percentage. So it seems like the pie chart kind of break segmentation is stabilizing more or less at these levels, at least for now. Look at fiscal '21, that was that pandemic year, let's call it, and commercial was way, way off. Remember, maybe you do remember, the airplanes being flown empty, remember that? Okay. Let's go on to Slide 14. Park loves niche military aerospace programs. This is a slide we always do. This is -- Donna does the presentation, he does a great job, and Donna works over the holidays and everything. It's really great duty by work by Donna. Elena is the one who comes up with the programs for the Park niche military aerospace slide. So I want to give her some shot at it as well. What do we have here, the ASTER 30 missile, those are blades, the Predator Radome materials, the Growler Radome, structures materials and the Poseidon structured materials. When you look at the pie chart, rocket nozzles, drones, Radomes, I would all consider those all to be niche markets for us. And we focus really on niche markets more than commoditized markets in commercial and military, especially military. Okay, so let's go on to Slide 15. Military markets. So not every slide we have is happy slide, but that's not what we're doing here. We're just trying to tell you what we think. The new world order, the sea change, the war in Europe grinds on. Many of the governments seem to be willing and maybe even eager to continue to sponsor and fund the war with military hardware and equipment and other things. And Asia is not a happy place either these days. There's now open talk about the possibility of nuclear war. You mean like the end of civilization on earth nuclear war. Is that the kind of the nuclear war we're talking about? Elon Musk wants to establish colonies on Mars to preserve human race in case we do not make it here on earth. You better hurry. This is a joke and not for us anyway. The bottom line for us is that we hope, we sincerely hope the warring nations find a way to end their war and stop the killing soon. What a waste of life. But even if they do, we believe the aggressive military buildups will likely continue for a while because there's so much ill will, fear and distrust in the world now. Let's go into Slide 16. Like I said, not every slide's a happy slide, but that's not our job. Our job is, I think, to tell you what we think. Slide 16, not surprisingly, there's currently much emphasis in many parts of the world, on aggressively expanding military budgets and spending in the U.S. and foreign countries and also not surprisingly, missile defense systems, including the PAC-3 Patriot missile. One of the key areas of emphasis for increased defense spending. That's probably in a shocker in the circumstances, the missile defense systems to be very important. And this is like the preeminent missile defense system, I think, for -- at least for a lot of initial systems, the PAC-3 I'm talking about. Remember, the Patriot missile that was in the first Gulf War back in the early '90s. Well, this is obviously next-generation. There's multiple generations after it, but it's been around for a while, actually. On Slide 17, Park supports the PAC-3 missile defense system with specially ablative composite materials. And our ablative composite materials are sole-source qualified in that program. Japan, South Korea, Taiwan, Germany, Switzerland, Poland, Netherlands, Romania are buying PAC-3 missile systems or upgrading systems. I think next quarter, we probably want to just give you a list of countries that are not buying the -- or not using the PAC-3 missile system. And during President Zelensky's visit to Washington, the U.S. committed to providing PAC-3 missile systems to Ukraine. That's a big thing because they've been asking it for a long time. So that's like the big gohona [ph] finally. Ukraine gets the PAC-3 missile system. So the last item on 17, Slide 17, we previously discussed we are getting a lot of indications about increased demands for ablative materials, and this RAYCARB C2B product to support the PAC-3 missile system and other missile systems. Let's go on to Slide 18. So just the first item, the check item, just kind of -- we're just updating you, we gave you prior indications on this number. As an update, Park is currently forecasting total fiscal '23 sales of ablative materials and RAYCARB C2B product to be approximately $7.5 million. So again, we're just doing that because we've given you indications in Q1 and Q2 when we want to update that indication. Serious supply chain and inventory management challenges continue to be potential significant strength in the pace of the global military build-ups. So why don't we continue? Let's go on to Slide 19. So what I think we'll do here, just to save time, this is one of the examples of -- this is an example of what I was discussing during the introductory comments before starting the presentation. This section of this presentation was included in our Q2 presentation. So we'll just skim over it. We're not going to take the time to go over in detail but I want you to have it. So that, like I said, you have one stop shopping. The Q3 presentation is holistic. You don't have to go looking around for prior presentations to figure out what we're talking about. Just on Slide 19, commercial aviation industry continues it's strong recovery. Let's go to Slide 20 quickly. They're watch items at the top here. We talked about these before. They haven't gone away. So important watch items. And the big question now at the bottom of the slide is if the commercial aviation industry falters, what will the commercial aircraft industry do, how will they respond. In our opinion, whether you're talking about Boeing or Airbus, the answer might be quite different. Let's go on to Slide 21. And the commercial aircraft industry is facing this kind of same kind of challenges everybody is facing at the top of the page. Interesting wrinkle is that international travel is recovering more quickly than people thought. And that's good news for the wide bodies. Go on that top of Slide 22, and that includes the Boeing 777X aircraft, which we'll discuss in more detail later on in the presentation. And silver lining, just to go over this quickly, again as jet fuel prices increase, that gives the airlines more incentive to switch off their older legacy gas-guzzling aircraft for the more modern fuel-efficient airplanes. They'll do it earlier than they originally planned as they have math, they have their own formulas and stuff like that, every airline does. It's not that complicated. It's all numbers. But as the fuel price goes up, that's a big variable. That affects the equation, and that means, okay now we're going to switch out our older airplanes earlier. So that's good news if you're supplying in to the new airplanes. Slide 23, GE Aviation, jet engine programs. We're not going to go over this in great detail. This slide, we include in every presentation with some minor modifications. Firm pricing LTA with a requirement contract from '19 to '29 with Middle River Aerostructure Systems. We call them MRAS, a subsidiary of ST Engineering Aerospace, which is a Singapore company. So all these programs here are GE Aviation programs. You're probably wondering, well, what does it have to do with Middle River, ST Engineering. Well, GE Aviation sold Middle River, MRAS, ST Engineering a few years ago. All these programs date back to when MRAS was owned by GE Aviation. That's the connection with GE Aviation even though GE Aviation doesn't own MRAS anymore, all these programs are GE Aviation programs as you'll see. We've done -- in fact we talked about that many times. We've built, we've done the PAC-3 for GE Aviation and for MRAS to support these programs. Sole source for composite materials for engine nacelles and thrust reversers for multiple programs, A320, Neo family, 747, 2 Comac airplanes and Bombardier Global. And then if you go to the bottom right corner of the page, we now start to talk about the 777X produced with our AFP composite materials. And I always like to say, a wonderful picture of the 747-8 engine nacelles and I love this picture because the person in the background there gives you the perspective on the scale and size of the structures. Let's go on to Slide 24. So we have a lot of slides update on GE Aviation programs, and we'll try to move through them quickly, but they are important to Park. So we want to cover them a little bit. First, I'll start with the A320neo family of aircraft and then with the LEAP-1A engines. That includes 19, 20, 320, 321, 321LR, 321XLR. The reason we say LEAP-1A engines is because A320neo program aircraft has two approved engines. One is the LEAP-1A engine produced by CFM, which is a JV between GE Aviation and Safran. That one is a CRDI engine. We're only on the CFM engine. So if an airline buys a A320neo and they specify the CRDI engine, then that's not -- there's nothing in it for us. They specify the CFM engine, then there's a lot of it for us. So just want to understand, maybe I should have made them more clear in some of these presentations. Anyway, let's focus on the A320neo, the aircraft part of it, discussed over many quarters that Airbus is aggressively trying to push up the rates and the supply chain has held Airbus back to a large extent. There's been some tension between Airbus and supply chain. And why don't we just move on because we discussed that tension and that dynamic many times in the past. Slide 25. So this is important. Airbus had indicated its intention to achieve A320neo aircraft family production rates at 65 per month by early 2024. And that was pushed back from mid-2023, which was the original target because of supply chain restrictions or limitations and 75 airplanes per month by mid-2025. Just so you know that's a lot, a lot of airplanes, no commercial program ever achieved those rates before. I believe that the A320neo, that Airbus was producing 63 per month before the pandemic hit. So they are still trying to claw their way back up to even that level. This airplane will, I think indisputably be the biggest selling commercial aircraft ever. Airbus also recently indicated its intention to achieve production and delivery rate of 50 neos per month by the end of 2022. Well, it looks like they did that, November, they got to 53. In December, preliminary report I saw yesterday, it was 58 in December. So that's a preliminary report. Hopefully, that number will hold, but that's what I saw in the report. Is that rate sustainable? I don't know. I mean Airbus certainly is on a mission to make it sustainable and move it up from there. One thing which according to Airbus is quite clear, is the market in the A320 aircraft family backlog, they are there to support these aggressive rates. Current backlog is 6,349 airplanes. That's a lot, a lot of airplanes, a lot of airplanes. And just to give you a perspective, at the 50 a month, what is that? 50 times 12, that's 600, right. Divide 6,349 by 600. That's over 10 years. So you see the problem that Airbus has, you want to order a new A320neo now? Well, I guess they have to give you a delivery of like 2034 or something like that. That's terrible. They don't want that. This is one of the reasons that they are trying to push the radomes that the lead times aren't so long. They obviously want to increase the backlog, but they don't want to keep increasing the lead times for these airplanes. Let's keep going. Slide 26. Okay, some recent disappointing news from Airbus. First of all, they said they wanted to ship 700 total commercial aircraft in 2022. Not going to make that -- didn't make it. I saw a couple of reports yesterday, maybe 640, 672, but they indicated, I don't know, maybe about a month ago that they weren't going to make a 700, so that wasn't a surprise. Another recent announcement, which probably is more impactful to Park. I'll just read from a quote, "Taking into account, this is Airbus, the fact that this complex environment will persist longer than previously expected, Airbus will be adjusting the speed of A320 family ramp-up to rate 65 for '23 and '24. It's not completely clear at this time as to when Airbus expects to reach the rate of 65 deliveries per month." So they're saying that, remember, they said what was it, going to be early 2024. Yes, early 2024 -- now they're saying, well, maybe that's not going to work. But they're not going to -- they haven't said what's the new target for reaching the 65 rate is, although they maintain that they want to be at 75 by the middle of decade 2025. So at this point anyway, they're not pushing that out, but they were putting a cloud over the 65 and when they're going to get to 65. Now it's interesting that there's been recent news that the engine companies are more or less caught up because if you go on to Slide 27, the engine companies were the main culprit in terms of slowing down Airbus' ability to ramp these rates. And the Airbus CEO recently confirmed that the engine companies are basically caught up. But there are lots of other supply chain constraints other than engines, forging, casting, you name it, it's a real challenge with the supply chain, real challenge. You know the story. I mean, with the pandemic, lots of companies scaled back, laid off lots, lots of people, and now there's an aggressive attempt to ramp back up and everybody is just flat-footed people just reported. So I was wondering, people still not going back to work. There's lots and lots of job openings available, lots of people that aren't working. So we won't go through that in any detail. I think you know that story. And a June 17, 2022 news release, we kind of staked out our ground, if you will. We said, look, we're going to support Airbus, don't matter what, no matter what the ramp rate is. And then as of the end of October 2022, there are some meaningful statistic data for you. CFM had a 60.7% share. Remember, the CFM shares, the A320neo program with Pratt, 60.7% so way over half and that's firm orders. This is not just speculation of the firm orders. And let's see -- how many were there? There is yes, right here, 6,816 firm orders for LEAP-1A engines. So over 10,000 firm engine orders. So there's a lot of bounce in that number. I mean it can move around a little bit month-to-month, but there's so many firm orders that are already in existence that, that share is probably not going to change so quickly. So the share obviously favors CFM, which is good for Park, as I explained. So on Slide 37, we tell you what we believe approximately how much revenue we receive for LEAP-1A unit. So maybe you can do your own math and figure out what this LEAP-1A backlog might be worth to Park. And like I said, Airbus wants to take more orders. That's like the whole world of it in terms of A320neos and I'm sure LEAP-1A and Pratt engines as well. Slide 28 the A321XLR, we discussed this probably several quarters now, pretty exciting program for Park, again, with the LEAP-1A engines. First test flight was in June with a Leap-1A engine, not a CRDI engine. You look at their single-aisle aircraft, it's the only single-aisle aircraft, which with 5,000-plus statute mile range, we'll go back to that in a minute. It's kind of interesting. And the other item highlighted here, Airbus recently conducted an A321XLR, long-duration test flight at 13-plus hours. That's a long, long, long time for a single-aisle airplane. That's kind of unheard of, actually. If you go on a 380 or 747, you might be up in the air for 12, 13 hours, but a single-aisle I don't think so. So and you know this, Boeing has said that they're not going to respond. They're not going to produce a new commercial aircraft this decade. They're not going to introduce a new commercial aircraft this decade. So Boeing has ceded this whole niche, this market to Airbus which is a good thing for Park, of course, since we are on that program. Slide 29, let's go on to some other GE Aviation programs. Comac 919, we talked about the big news last quarter. The bigger news is that Comac got their production certificate for the C919. Now the production certificate is a real big deal because that allows Comac to go into volume production in this aircraft. Production certificates are often more difficult to obtain than Type certificates. There's a lot more fanfare about Type certificates. But there are a lot of airplanes that got Type certificates, never got production certificates and never heard of them and because they didn't go into production. So production certificates are, I guess, not as much fanfare often, but probably more significant. That's a big deal they got the production certificate. And there are 686 firm orders for 919 at this point, all for the Chinese market, I suspect. They have LEAP-1C engines, CFM again. On Slide 30, we haven't really discussed the COMAC ARJ21 very much in the last few quarters. But we just saw a report recently that there were 26 ARJ21 aircraft delivered in '22. That's more than we expected. So we thought we'd highlight it for you. I mean we're happy to be on the program. We're going to say, again, this is for the Chinese market. Slide 31, we discussed the Bombardier Global 7500 and 8000 in the prior quarter. So we probably won't spend a lot of time on this slide. Mach 0.94 Max cruise speed, that's pretty fast. I think that they broke the sound barrier doing some in the test line, which is interesting. Slide 32, still with the GE Aviation area, we decided we'd provide a whole slide on the 2 slides on the fan case. We haven't done this in the past because the 777X program had been kind of dormant and maybe in limbo. We weren't sure -- people weren't sure what was going. But it seems like it's going ahead. The fan case containment wrap for the GE9X engine for Boeing 777 aircraft, that's our end of the deal the fan case containment wrap. Let's talk about the aircraft, the 777-8 variant, over 10,000 statute miles. Remember, I was saying that 5,000 statute mile range for the XLR is a big deal. This is not big league for wide bodies, 10,000 statute mile range. That's gone a long, long way. 425 seats depending on the -- how they set up the seat arrangements. And since the 747 and A320 programs have been canceled, there's no other commercial aircraft, which is anything close to those range in passenger capacity capabilities. So this is going to be an important niche, could be an important aircraft for Boeing. Hope it works for them. I'm not aware. I don't think anybody is aware that Airbus has been trying to develop an airplane to compete against this airplane either, the 777X. Passenger and freighter version certification expected in 2025. This picture was sent to me by a friend of mine from a company called Alaska Air Fuel in Fairbanks. The airplane is on the ramp, at the Alaska Air Fuel ramp in Fairbanks. It was up there doing, just one a test aircraft doing cold weather testing in Fairbanks in the winter. And if you want to do a cold weather testing of an airplane, Fairbanks is a place to go because you can easily see minus 40, minus 50 degrees temperature. So I really like that picture I put to share with you. Slide 33, I'm trying to move a little faster, I guess. So continuing with the 777X program, there was a little bit of interruption in the test program and it's has been resumed, 353 firm orders. And what do we do? We produced composite -- AFP composite materials for the GE9X fan case. We have significant per engine content in this program. And we recently quoted materials for the program exceeding $1.2 million. Why am I sharing that with you? Not so much a number, just to say, yes, this looks like it's getting real now for Park. We haven't seen the POs yet. I want to make that clear, but we did receive a quote request for -- and we did quote $1.2 million approximately for delivery in 2023. And remember, there's that design risk. We've talked about this in the past. The company that makes their fan case is trying to read us in their fan case, so our case wrap is not necessary. So the fan case can pass the fan blade out test without a case wrap. Slide 34, 747 queen of the skies. The last 747 rolled out of Boeing Everett, Washington factory, December 6, 2022. It was unit 1,574. It will be delivered to Atlas Air in early 2023. First, 747, we delivered to Pan Am, January 22, 1970. This is the airplane that changed the world. It's heartbreaking at least for me to see this program end. This picture was taken October 10, 2022, in Anchorage, obviously Atlas Air, 747-8 and they get the last one. So anyway, okay, I took that picture. Let's move on to Slide 35. Yes. So this is where it gets a little complicated. You kind of think what the heck is going on here. If you look at the history on the left-hand side of the left-hand column with the numbers, see in fiscal '22 and fiscal '23, that's $6-plus million per quarter for GE Aviation program sales history and forecast estimates, so $6 million to $7 million per quarter. The prior year was the pandemic year. So the number is much lower. But in '22 and first two quarters of '23, over $6 million a quarter. And then in Q3, just $5 million, the recent quarter, $5 million. And we actually estimate I think [indiscernible] quarters for three quarters when we did the Q2 presentation. So we're gaining a little bit above that but still well below the history. So I think what's going on here. The programs are going -- aren't going down. The programs are going up. Let's go to the right side, GE Aviation program sales forecast estimate for Q4. So we're now, again, estimating $4.25 million to $4.75 million. And if you do the total, that's just adding up the year-to-date through Q3 with the estimate for Q4. That just the math. But I want to mention to you that we have $5.8 million already booked for Q1 for fiscal '24 Q1, and we would expect to book more in 4Q book and ship more than that. So what the heck is going on here? And that could be a watch out sign, maybe a warning. So let's go on to the next slide. What the heck is going on here Part 2? So downstream inventory, production management challenges, dislocations, causing serious misalignments between the aircraft program rates and the Park's material production rates. At some point, maybe soon, those misalignments will be unsustainable and will reach a breaking point and the day of reckoning could lead to abrupt and even wrenching adjustments and realignments. It's just math. If our production isn't matching what Airbus is doing and the other companies that are using these GE engines than something's got to give at some point. Remember, we're sole source these programs. On a day-to-day basis, downstream dislocations create major challenges for Park in managing our production and supply chain activities. We're trying to get some visibility and we keep getting these kind of strange indications as we saw in Q2 -- sorry, Q3 and now Q4. But this is a big one for us anyway. Over the long term, only things are two things which matter to Park in connection with the GE Aviation programs we support are. How many airplanes are delivered that have these engines on? The LEAP-1A, A320neo with LEAP-1A, 919, the ARJ21, the Global 7500/8000 on the 777X. The other thing that matters if you want to complete the equation is the top of Slide 37, the expected Park revenue per engine unit for those programs. Based upon Park material usage for engine units for those programs, which usage is given to us by our customer. So starting in 2025, we're getting this information because we kind of got exacerbated trying to predict what's going to happen. We're going to tell you -- we're telling you now what our estimated revenue per engine is, and you could decide how many units you want to assume in terms of doing the math. Starting in 2025, based upon the program engine material usage information provided to us by the customer, the estimated Park revenues by program end unit is approximately as follows. So for A320 neo family, $30,500, for the ARJ21, $29,500, the 919, $26,500, the Global 7500/8000, $49,000. Now there are assumptions contained in each of these items, which you need to look at. We're not predicting those things will happen. We're just doing the best we can to kind of guess as to what will happen based upon indications from our customer. And this particularly relates to LSP and film adhesives, which programs we'll be using our LSP products that are not using them now and film adhesives that are not using them now. So we have to make a little some assumptions there. But we made the assumptions we think are reasonable, but they may or may not be correct. I just want to make sure you understand that. The last item, GE9X fan case, it's significant. We're not going to give you a number yet. It's still kind of a new program. I think it's a little early to do that. And of course, there is a risk that the program -- that the fan cases we designed in the program doesn't continue. So okay, Slide 39. Now let's talk about Park's financial performance, history and forecast estimates. Nothing to overshadow here, I don't think, but I just want to mention to you that we just kind of covered this. You look at their sales numbers for fiscal '20 -- the quarter for fiscal '22 and '23, remember through Q2 that the GE Aviation program sales were $6 million plus each of those quarters, right? Then in fiscal -- in Q3, the current quarter only $5 million, but the total sales were still $13.9 million. Somebody who's pretty smart figured it out what's going on here. Well, obviously, we're getting to those numbers by making up the lack of GE Aviation sales with non-GE Aviation sales. They look at the forecast for Q4, $13.5 million to $14 million we're estimating but we're only estimate of $4.5 million GE Aviation sales. So again, I think you should be thinking about that. Well, it probably means that the non-GE Aviation sales are moving the right direction. EBITDA estimate $3 million to $3.5 million. And for fiscal '23, again, we're just trying to doing the math. We're taking year-to-date and added the estimate for Q4 and those are the numbers we come up with. Let's go on to Slide 40. And this we're going to skip because we covered these comments and thoughts about our forecast and outlook during the last couple of quarters and there's not really not too much change to them. We feel -- just to reiterate that to provide a long-term forecast under the circumstances, with the great uncertainty that we're dealing with wouldn't be that meaningful. And if you want to skip, we can do that to Slide 43, the end of this section, we're saying that based upon all these considerations, although there are serious concerns about the economy inflation, workforce shortages, supply chain challenges, we believe the outlook for Park is quite positive. So we don't think that we're in a position to provide a meaningful long-term forecast with numbers. But we are able to say, based upon this discussion, that we think the outlook for Park is quite positive. So let's go on to Slide 44. Just some quick updates here. The expansion is basically complete. The qualifications should be done in a few months. And middle picture, we haven't -- and there's the top and bottom picture, we showed those before. The middle picture though is a passage way between the new plant and the old plant. We're looking at from the new plant, looking into the old plant. And if you look at the top picture at the back you see that the passage right at the top of the picture, I don't know if you could see it. There's a sign in this picture, the best way picture on the right. And it basically says it's a fire door. And if there's a fire, that door will close automatically. Why is that? Because terms redundant factory, so there's anything that goes -- happens to one factory. You want to make sure it's isolated, so it doesn't migrate it to the other factory. Why don't we go on Slide 45, James Webb? So we talk about this every quarter. No more revenue for Park. I don't think we're going to get any more product up in the James Webb Space Telescope. It's 1 million miles from earth right now. But it does have our '21 SigmaStruts incorporated into structure. And those struts are critical. We have those that struts, telescope structure wouldn't work, it wouldn't happen -- just would collapse. Couple of interesting items, the James Webb spotted concentric angular rings around a giant star showing the first reasonable evidence of light pushing dust around the right of it is an image of that. I've no idea what it means, but to me, it just seems very all inspiring. And it James Webb uncovers dense cosmic knot in the early universe, again, that's way above my pay scale. But to me, it just seems so inspiring to hear are those kind of things about our comprehension, new comprehensive, new wind sites, let's put it that way into the universe. Slide 46, okay. So we talked about this Aero Design Labs program over the last couple of quarters, the ADRS program. Park's materials are currently sole-source qualified on this program. There are over 6,000 Boeing 737 engine aircraft in service. This program is for the Boeing 737NG aircraft. In May 2022, the ADL received an STC for the 737-700. In November, ADL entered into an MOU with Delta to do the testing and certification for its kits for the 737-800 and 900 variants. So that's all good. And based upon the forecast provided by the customer, Park expects to receive revenues of approximately $2 million in calendar year 2023 related to this program. Actually, a good portion of it's already booked, I think. But why we're telling you that, only because we want you to know that this seems like it's real. It's happening. We're not the customer ADLs at the current low key. We're not going to provide additional information about the program, the expectations, the forecast, we're not going there. But we wanted to at least cover this. And the part about Delta, that's public. That was in the news release, we're not disclosing anything that you probably don't already know. And we'll consider additional investment for this program if necessary. This could be a big thing for Park. So we're happy about that. Let's see what happens. Slide 47. Okay, last quarter, we talked about AFP, updated Park on potential automated Fiber Placement, AFP manufacturing project initiative. We originally discussed this during our Q2 call, as I just said, let's do an update. Not much of an update project that's under series consideration and review. We haven't made a decision yet. It's a front burner project for us. We're seeing a lot of high-level attention to focus. However, I just want to let you know, there's the potential AFP manufacturing project is competing for high-level Park management attention to focus with the potential major multi-front JV project with a large aerospace company. This is something that's just been developing in the last over months, but it's got to become a fun version project as well. The potential JV project is ongoing serious consideration to review receiving a significant amount of attention. So there's somewhat of a balancing act for little Park to manage both these important potential opportunities at the same time. Good problem to have, just wanted to know that. This should be a real word part of it. Let's go into 48. Now these slides are the same slides that were included in the prior presentation about the potential AFP project. Through us, AFP is a very interesting potential strategic opportunity for Park. And in the slide, the next few slides, we go through the reasons why we think AFP is interesting, but we're not going to go back and review all the slides just to save some time. Obviously, you have any questions, let us know. But Slides 48 to 51 were pretty much what was contained in the Q2 presentation with some minor changes. Let's go on to Slide 52. We're almost there. The Park family, updates on Park's great customer Flex program. We feature this every quarter, and we should because it's really important. It would just not be possible to continue to get the job done under current very challenging circumstances without our customer Flex program, just not possible. Park's current people count, 112. Well, that's some progress. It's still not we want to be, but our current people count of 112 was up from the people count of 99 reported in our Q2 investor presentation. The great news is all the progress we made has been made the right way, the Park way, the little picture of a few of the guys that won our 2022 holiday party paper airplanes throwing contest. This is an annual event at Park. So congratulations to those guys, and we're [indiscernible] now. But I want to point out something. In Q3, we were kind of limping along at 98, 99, 100, 101, 102. It's only after Q3 that we really ramped up to this 112 number. So everything that was done, everything got done, the 13.9 million that was shipped in Q3, we shipped a very, very stressed staff, a very short staff, maybe 100, 101, 102. I just want you to be aware of that. Slide 53, we do not sell out or compromise our sacred principles in order to recruit the additional people we need. That's really important. And just so you know, other companies, multi larger companies continue to aggressively target our people for recruitment. Now a question. Will they feel bad if sooner or later, they know -- we all know they will, what will these larger companies do with the people they aggressively recruited. So yes, we don't know the answer to that question. As soon as these people aren't needed, they'll be thrown out like yesterday's garbage on the garbage sheet, which is what happens every time in the past. That's why I'm saying that. I don't think that's an outrageous comment. That's exactly what happened every time in the past. And you think that in the boardrooms of these companies that are hiring 1,000 people a time, throwing money, hiring bonuses, big money at these people, you think you're agonizing and hand wringing over, oh my god, what happens when the aircraft rates go down, what do we do with those people? It's not even being considered. Why? Because we know what they're going to do. They're going to throw them on the garbage sheet like they always do, the people they hired. But the good news is that we continue -- Park continues to make progress recruiting and the training people in the right way, the Park way, notwithstanding what these other companies might do or not do. When we hire someone, our attitude is we hire for life. We won't casually just so many people we hire, let's bring on 25 people. They're for life. Now it doesn't mean there are plenty of people Park is not right for them or vice versa. If that's the case, somebody doesn't have the right attitude for Park, they're not going to stay at Park. I'm not talking about that. I'm talking about good people, the right attitudes, our attitude and we hire somebody. We think about it carefully, seriously. We're committed to them for life. We're not going to throw them in the garbage sheet as soon as our business is down. We didn't do that during the pandemic. Our business where we had less than -- I think, we had $9 million of sales in quarter. We didn't do it then. So that's not our intention. Our attitude is not -- people are not commodities, are not pork bellies to be traded, bid up and bid down that's different. So that's when I say we do things the Park way. That's what -- that's one example of what we're talking about. Let's go on to Slide 54. Our people have been through a lot together over the last few years and many challenges and hardships and diversity to overcome. I won't read you the list, you probably can figure it out yourself. The wonderful news is that having endured and overcome the hardships adversity and challenge together, our Park family has overcome -- has come together more closely and tightly than ever before. With a dedicated, motivated and inspired workforce, a company can move mountains. Without such a workforce, a company to move nothing. And our people are moving mountains. To have 100 people push out $13.9 million in the quarter, there's some mountains being moved. I'll tell you that. Park is very fortunate and has the wonderful people we have. The last slide, this is the Christmas party, and you can see some of these folks with the Christmas ugly sweaters. This was -- this is probably most of the Park people. It's not all 112 of them, but we have a very nice Christmas party in which we take a picture of the Park family for you. So sorry that went on so long. We're just about an hour into the presentation. So operator, we're ready to take questions if there are any. Thank you, everybody, for listening so far. Thank you. [Operator Instructions] Our first question comes from the line of Nick Rispatella [ph] with NR Management. Please proceed with your question. Hi. Thank you. First of all Happy New Year. And again, thank you for your very comprehensive presentation. I listen to so many conference calls and really Park has about the most comprehensive presentation. That's wonderful. First time in all my years, I've ever seen Vito Corleone mentioned in a presentation, by the way, I got a kick from that. So my question is, -- and I know this might be a little difficult for you, but the language you have in the slide about the China program, Comac, significant upside potential. If there's any way you can quantify in your wildest dreams or just a range of what this might mean for Park a couple of years down the road. That's first. Secondly, it is China. There's a lot of, let's say, tension. Do you see any risk politically for Park as a supplier in this program? And then finally, and this is kind of just a big picture question, Brian. How would you characterize Park's competitive position, your moat for lack of a better word? Thank you. Thank you, Nick, and Happy New Year to you. I appreciate the input. And just let me say, to the extent people are still listening, if there is anything you would like us to cover in presentations in the future, please let us know. This time is your time, it's not our time. It's not our opportunity to hyper promote our company and tell you how smart we are. It's an attempt to communicate to you what we think might be meaningful in terms of understanding Park, our business and our objectives. So Nick, the 919 program, what's the upside potential? So right now, it's basically a kind of almost zero. And the question is how many 919s Comac produces. The good news for Comac is they have a captive market, which is the Chinese market, and it's a controlled market and the Chinese government will dictate to some extent, my opinion anyway, what Chinese -- what airplanes the Chinese airlines are buying. So we've seen some numbers coming out of Comac, and we're reluctant to pass those on. We're not sure what they mean, and in terms of forecast and the ramp rates and stuff like that. So we're reluctant to pass those on. We're not sure how much we can count on them. But I mean, starting at zero, I mean let's say, they got to 100 airplanes per year. I'm just putting that number out there as compared to 75 airplanes per month, which is what the A320neo program is -- target is. That's still a lot of revenue for Park. And what we did this time is we actually decided we give you the revenue per program, so you kind of do your own math. Obviously, I think you know this, there are two engines for C919, so you have to multiply that by two. The good news with the 919 is that engine, the LEAP-1C engine sorry, that program only uses a LEAP engine, only uses CFM engine. It's not a shared program with Pratt. So all the C919 that are produced are going to be used in that LEAP engine, LEAP-1C engine with the Park materials. The risk -- it's a good point. I don't know how to quantify it. I would never say never. I guess the counterargument or consideration might be this that the 919 is a very important prestige program for the Chinese government. And there's a lot of risk in changing. Once you get an aircraft going, there's a lot of risk, a lot of expense, a lot of hassle and change in courses midstream. So for them to decide they want to change engines or change suppliers and their cell structures, anything is possible. But it's a lot of effort, a lot of risk, and it's a risk for their program, which they know the world is watching is my opinion again. And I don't think they want a hiccup. So I think they want a smooth introduction of this airplane into the market. They want the world to see how that's -- the world to be impressed with how it's going. So I think they're going to be reluctant and they are smart to throw variables into the program that really aren't necessary for them that could cause some setbacks in the program that aren't necessary for them. They look at the big picture. There is some talk. I think we discussed this maybe a couple of quarters ago that Comac or the Chinese government, I don't remember where it came from. It's kind of the same wants to have a Chinese alternative -- Chinese engine alternative to the LEAP-1C from 919 by 2025. And I would say I'm highly skeptical about that target. I don't think that's realistic. And I haven't heard that coming out of China for a while. So I think maybe they -- again my opinion, maybe decided to kind of back off on that target. Ultimately, China wants to take whatever technology, airplane technology, electronics and have much Chinese content in this technology as possible. So we'll have to see what happens. There's a risk -- and I don't know how to quantify, I guess, maybe the only other comment I would make about the risk is it's probably, in my opinion, a longer-term risk rather than a risk that would have an impact, let's say, through the end of this decade. And you're right, there are definitely are tensions. I think just one other comment GE has a lot going on in China, a lot of inroads in China as much as their attentions. They are also symbiotic relationships where both parties are kind of dependent on each other as much as they may not want to work together. They kind of don't have any choice. And they're being practical, and want their programs to succeed. Let's see. The last question was it -- how we're different, how unique from our competitors. So that's a good question, maybe good better question for our customers, ask for our customers. My perspective on it is probably many different kind of things. At Park, we have a pretty extreme culture. And for me, if you really want to have culture, you need to be willing to live and die by it and not just going to talk about it in the board room somewhere. And for us, we try to do things consistent with our culture, not just talk about it. One of the things that is kind of a calling card for Park, there's flexibility, responsiveness, urgency. The aerospace industry is kind of strange. It's well, yes, it's 9 months, 12 months, whatever lead time. And okay, I guess that what it is. We -- that's not for us. We don't want to kind of get ourselves range into the kind of mindset. So I would just maybe list that one item as maybe distinguishing factor between Park and our competitors. Hey, Brian, Happy New Year. Thanks for taking the question. Yes. Just got a couple of questions. First, to start off, for the AFP initiative, you noted a potential major multi-front JV project with a large aerospace company. Just curious what does multi-front mean? Multi-front means there are really two different major initiatives that relate to the JV discussions. And at this point, I think it's too early for us. It wouldn't be appropriate for us to discuss what they are. But both of them are significant initiatives and there are different types of things. This was raised by this company. It came from their side, originally, two concepts. And I'm sorry, I wanted to put it out there because I want you to know that kind of in terms of transparency that we're juggling two major projects, AFP project as well as the multi-front JV project with this large aerospace company. And I'm sorry to do that, please maybe we've raised curiosity up too much, but we're not really in a position to provide any more information about what company that is or what these JV opportunities relate to, but both of them are significant in their own right. I mean even if we only did one of them, which is possible. They're not dependent on each other, it still would be significant. Okay. No worries. It definitely piqued our curiosity and very encouraging to hear. My second question is more of a housekeeping and modeling question around the rate card C2B sales. I think in the past, you noted you expected like a pretty small amount in Q2 and Q3. Based on your updated expectations, is it fair to assume the majority of what's expected for the fiscal year is going to accrue in Q4? And is it possible to quantify these amounts just for our modeling purposes? Let me just quickly check if I can find that information. Yes, so about half of that number is expected in Q4. That's correct. But half that $7.5 million number is expected in Q4. So that's a correct observation. Okay. It's nice to see the increase in headcount. I know it has been a struggle over the past year or two. And you noted it was kind of a sudden increase after Q3. Did anything change at Park in its hiring strategy, or was it just the labor market being a little more cooperative? We didn't change our strategy. We stuck to our principles, like I said. There was one event though, that took place in our little town in Newton. I mean it's about 30,000, which is there's another company that has been in Newton for a long time, not in aerospace that shocked everybody by closing its doors with maybe one week notice. What surprised us about it is that this is one of the companies that was aggressively hiring people with hiring bonuses and big pay packages up until the announcement. So that was a good opportunity for us, and we've hired a number of people from that company, so local people, which is really good. We rather our preference, especially for production people to hire people that are local rather than from Wichita. So that helped us a lot. We didn't changed our approach. We didn't change our standards or we didn't do any of that. It was just we had some people who were available, all of a sudden. And look, I mean, I don't know what's going to happen to the economy, but it's possible we'll see more of this in the future. Yes, definitely. You noted that even with those hires, you're not still where you want to be. I mean, how should we think about like what is an optimal level of headcount for Park that you still need to get to? So that's a good question and something we're actively discussing and really, it's not a black one answer. It depends on how we structure the shifts. The norm will be a little different. But I think another half a dozen people approximately maybe up to kind of like 120, we get to a point where we feel pretty good. Maybe you want to do some fine-tuning, but we're certainly lot closer to that number than we were when we were down at 99 because the requirement hasn't changed. It's not like we needed less people when we were at 99. So moving in the right direction anyway. Yes. No, that's for sure. Maybe one last one, a quick one. I know there's limitations on the ADRS program in terms of what you can tell us, but really encouraging to see the $2 million forecasted for calendar year 2023. Is that something you guys are already producing? Or is this still kind of tentative on when production will start for the -- to produce the kits for the program. Some of that is booked, a good portion of it is booked. I think maybe about 40% of it. And we have orders to ship in our fourth quarter, our fourth quarter, meeting the next two months. So I think it's real. And that's the reason we provide that number because we just -- $2 million kind of a round number, but we wanted to communicate or we want our investors that this is not just something we're talking about as a prospect anymore. It looks like it's really going to happen. It looks like it is happening. Yes, it seems like it's going to be very pretty significant, so definitely encouraging to you guys are on the program. All right. Well, that's all my questions, Brian. Thanks for -- once again, thanks for taking them and Happy New Year. Hi, good morning. Thanks for taking my question. I'm trying -- this is sort of a broad question. I'm trying to understand what portion of the demand for your products has been destroyed by the pandemic and related economic chaos and what's just been deferred? And for me, maybe the way to think about it is to go back basically three years ago, right before the pandemic started. And you went to the Needham conference. And in your presentation, you had a long term for what you call the long-term forecast estimate. And you had sales growing over the four year period to $94 million to $100 million for fiscal year '24. Now if I look at -- if I take your nine months numbers and add your estimate for the fourth quarter and then apply the breakdowns that just for the nine months, it seems to me that your commercial business is back to pre-pandemic levels and your military business is back to pre-pandemic levels. But the business is off by I don't know -- if it's maybe half or a little bit more than half of what it was. So if you say, if I were to argue that the demand has simply been postponed by, say three years, do you think that you could have $94 million to $100 million of revenue three years from now in fiscal year '27? And if not, what's sort of changed over this three year period about your sort of outlook for the potential? Okay. Well, thank you, Daniel. That's a good question. As I've said, we're not -- we don't feel comfortable providing a new long-term forecast because all the short-term uncertainty. As explained, we think the outlook is good for Park. But it's a really good question, like how much has been deferred. You used the term destroy in your question. I'm not aware of any programs that were destroyed, but a lot deferred. And we're not quite back to where we were. I think in the pre-pandemic year, our sales were $60 million. We're not quite at that level yet. And... Yes, I agree. So for example, I mentioned that the A320neo program was producing at 63 airplanes per month before the pandemic. And the number I heard for calendar '22 was only 41 per month. Now they're up to 50, maybe a little bit more. They're trying to claw their way back. but still quite a bit less than it was pre-pandemic. And that's probably a good kind of metric for other programs, especially in the commercial area. Military is a little different because it adds a different kind of different drivers, different dynamics, I would say. So we just want to say we're going to shift everything three years. I don't think we're quite prepared to do that because of so much uncertainty. But the concept it doesn't make sense because I'm not aware of any programs that just went away and just died. Well, I shouldn't say that, the 747. That was probably a victim of the pandemic. And that was never a major program because it's already pretty small. They were only doing about six airplanes per year, 24 engines. So I think I mentioned that was probably a little under $2 million per year for us. So that's true. The 747 that went away and some people would argue maybe would have went on its way anyway, but who knows. But it's probably a very few examples of that. Probably mostly things were deferred and not quite back to where they were. And the A320 program, like I said is a really good example of it that not anywhere close to back to where it was now. That's not Airbus' choice. They have lots and lots of orders. They like their production rates to be up to over 60% at this point but just a lot of -- they're struggling to get there. And the big issue is supply chain, supply chain. Well, we talked about what happened the pandemic occurred, it was really Armageddon. I mean it was very frightening times because we didn't know what's going to happen. Not only it was bad what had happened in terms of the contraction in the industry, but I mean people are really talking about the world coming to an end. So what did companies do? They slashed and slashed and slashed, just to survive. And then they start coming back a lot more quickly than expected, and they're just totally beyond the power curve and have not caught up yet. I think the Airbus guy, the CEO said, maybe by the beginning of 2024, the supply chain will be back in shape and have caught up. But I mean, I don't want to be disrespectful, but he keeps pushing that date back because he's said other predictions that supply chain would be back in kind of normal shape earlier than that. So I'm rambling here a little bit. I think, Park, just one other comment, maybe part of our ability to get back those numbers are can be based upon these programs, getting back to where they're supposed to get to. And then these are the things like these other opportunities like ADL, for example, the PAC-3 I mean I don't know where that's going, but it seems like everybody in their brother and sister launch PAC-3 missiles these days. So it's hard to even quantify what the upside is there. I just read the stuff you could read about this country, that country, they're all adding PAC-3 missiles. And AFP, that would be another example of a long-term strategic example of additional revenue, this joint venture that we're talking about. Another example of significant upside revenue. But I think when we gave those forecasts, Daniel, I think at that point we said, we're not looking at kind of -- we're looking at our current business, our current business is growing organically rather than acquisitions and large joint ventures. So maybe I should take the potential joint venture out of the equation for this discussion. So let me follow up. Last quarter, you had a slide where you noted that assuming a 59.5% leap market share, and 75 per month build for the A320neo, that represented approximately $32.5 million per year of revenue to Park starting in 2025. And I'm just curious, if you can remember back three years ago when you were making your forecast for the business with the LEAP engine, did you imagine that it would grow to a larger number than $32.5 million? Or is $32.5 million sort of what you've been expecting all along? For the LEAP engine. I don't remember exactly what we were thinking about when we did that long-term forecast. But I guess I would say that I'd be surprised that long-term forecast contemplated a rate of over 75 per month. That would be surprising. So the dynamic has changed. I mean we talked about this over the last few quarters. This is my opinion again, but not completely because Airbus has been pretty vocal about this. They're on a mission. They're in a mission, single aisle to do what, to make Boeing a second-tier supplier. They see an opportunity, they're going forward. They're trying to be aggressive as possible. They feel that Boeing has been weakened, so they want to take advantage of it. So they want to emerge from this whole thing where I don't think they're thinking of putting Boeing on a business where the single-aisle offering from Boeing, the MAX is really much less than the A320neo. And we talked about the XLR. That was something that was not on the table. We treated that long term forecast three or four years ago. Boeing doesn't have a response to the XLR. They said they're not going to develop a new airplane in this decade. So I think that's a new dynamic which partly was caused by the actions with the MAX and then the pandemic, which makes Airbus even more aggressive in their mindset than they were previously. So I'm just rambling here a little bit, if you don't mind, but I doubt we'd be contemplating more than 75 per month, even three or four years ago. And just to complete the thing about what that's worth. The reason that we gave you the revenue per engine is so you could figure it out. We provide you the market share that LEAP has as compared to Pratt. And we tell you that the people at Airbus are still talking about per month by 2025. But you read the stuff, same stuff I do, is 2025 a realistic time frame? Some people would say maybe it's not. Although Airbus is not back of off that but I guess I would just add one thing, which is that in my opinion, is Airbus will get there. And maybe people could argue maybe it won't be 2025. But my opinion is they'll get there. They're highly motivated to get there, highly motivated. Okay, and if you permit me one last related question. So as I've noted, your business jet business has fallen off quite substantially since the pandemic started. What are your sort of opinions about the prospects for that recovering? So our business jet business is the biggest program that we have in the business jet segment is a Global 7500/8000, which is a good program to be on. And we have a lot of content on that program also per engine unit. That's kind of maybe the leading big, big, big business jet. Right now, Gulfstream has kind of come up with an answer in terms of the range capabilities of size. My opinion about the business jet industry is this. And just an opinion and I just want to say that, people will disagree some people will anyway. My opinion is that a recession is coming this year. And then the question is, how does it impact the business jet industry. My opinion again is that it will impact the industry differently in a different way, for the really big business jets as compared to a swan mid type business jet, why is that? The Global 7500/8000, I think it's $78 million per unit. So we're talking about a lot of money. This is not the average regular wealthy guy. These are large corporations, [indiscernible] Elon Musk types. Recession, are they going to hesitate to buy a $78 million airplane? Probably not, in my opinion. So I think the Gulfstreams and the Bombardier and the Falcons will probably do better in a recession. Now the smaller and midsized jet, that's a different market. That's a different buyer. Maybe it's a guy who has four or five car dealers and he wants to have a jet, maybe now not a $75 million jet. It might be $5 million to $10 million. That guy probably doesn't have $500 million or $600 million in a bank and he's more vulnerable to recession, and that guy might be affected more in his terms of just buying attitudes about jets than the guy or the company who buys the $75 million airplane. So my feeling is that the larger aircraft, Gulfstream, Bombardier, Falcons will do better. The smaller jets, maybe will be more affected by the recession. And I also would base that opinion upon past history. In the past, when receptions have occurred, economic downturns have occurred. The companies that made the smaller business jets were hurt badly. And I'm not aware of any reason why that pattern or dynamic would be very different if there's another recession. There are no further questions in the queue. I'd like to hand the call back to Mr. Shore for closing remarks. Thank you, operator, and thank you all for listening. We appreciate it very much. Have a happy New Year. All the best to you and your family in 2023. Feel free to give us a call any time if you have any follow-up questions. So thank you, and take care. Goodbye. Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.
EarningCall_1423
Ladies and gentlemen, good day and welcome to the Infosys Limited Earnings Conference Call. [Operator Instructions] Please note that this conference is being recorded. I now hand the conference over to Mr. Sandeep Mahindroo. Thank you and over to you, sir. Thanks, Indra. Hello, everyone and welcome to Infosys earnings call to discuss Q3 FY ‘23 financial results. Let me start by wishing everyone a very happy New Year. Joining us today on this call is CEO and MD, Mr. Salil Parekh; CFO, Mr. Nilanjan Roy; and other members of the senior management team. We’ll start the call with some remarks on the performance of the company by Salil and Nilanjan subsequent to which we will open up the call for questions. Kindly note that anything which we say that refers to our future outlook is a forward-looking statement that must be read in conjunction with the risks that the company faces. A full statement and explanation of these risks is available in our filings with the SEC, which can be found on www.sec.gov. Thanks, Sandeep. Good evening and good morning to everyone on the call. Thank you for joining us. We are delighted to share with you that our Q3 performance was strong with year-on-year growth of 13.7% and quarter-on-quarter growth of 2.4%, this in a seasonally weak quarter for us and amid a changing global economy. We continue to gain market share. Growth in Q3 was broad based with most industries and geographies growing in double-digits in constant currency. Growth in constant currency for 9 months of FY ‘23 was 17.8% compared to the same period of FY ‘22. Our large deal value was $3.3 billion, the highest in eight quarters. With 32 large deals, this is the largest number of large deals in our history, 36% of this is net new. Our pipeline of large deals remains strong. Our digital revenue grew at 22% in the quarter at constant currency and are now close to 63% of our overall revenue. Our core services revenue grew at 2.4%. We are seeing growth in both areas of our business, digital and core services. This is a testament to our industry leading digital capabilities, including our Cobalt cloud capability and our industry-leading automation capabilities, both of which are resonating with our clients. Our large deals pipeline is seeing increased traction for automation and cost efficiency programs. Our results reflect our deep rooted client relationships, coupled with client-centric strategy, differentiated digital and cloud capabilities, strength in automation and the ability to pivot our business rapidly to changing client needs. Our cloud revenues continue to have healthy growth this quarter. Our clients are focused on accelerating the digital and cloud transformation, both to grow and to become more operationally efficient. They chose us to partner with them through the complexity of managing this change, because of our differentiated capabilities. Our industry leading cloud offering Cobalt is playing a key role in helping them navigate the digital transformation. Two examples of this, Cobalt is helping accelerate business growth and resilience for a large telco and making the decision-making more data driven. We are supporting a leading aerospace company by automation of the customer experience area leveraging a modernized technology infrastructure, driving material cost efficiency. Strong growth is accompanied by stable operating margin at 21.5%. This was driven by healthy revenue growth and cost optimization benefits. Our operating margin for the first 9 months of FY ‘23, are at 21%, in line with our margin guidance. Our voluntary quarterly annualized attrition continues to decline steadily and reduced by 6 percentage points sequentially to well below 20% for this quarter. We are encouraged by the immense confidence and trust that clients have in us. The signs around us around the slowing global economy are visible. Some areas such as mortgages and investment banking and financial services industry, telco, high-tech, and retail are more impacted and that is leading to delays in decision-making and uncertainty in spending in these areas. We are confident that the strength of our digital and cloud capabilities and our automation capability will continue to position us well in the market. We are keeping a close watch on the global economy. Driven by our growth of 17.8% in constant currency for the first 9 months of FY ‘23 and strong large deal value for Q3, we are increasing our revenue growth guidance, which was at 15% to 16% earlier to 16% to 16.5% despite the changing global economic conditions. We are retaining our operating margin guidance for FY ‘23 at 21% to 22%. We anticipate to be at the lower end of this range. Thanks, Salil. Good evening, everyone and thank you for joining this call. Let me start by wishing everyone a very happy and safe 2023. Q3 was another quarter of resilient performance. Our revenue grew by 13.7% year-on-year and 2.4% potentially in constant currency terms despite seasonal weakness. Most of our business segments and geos grew in double-digits year-on-year in constant currency. Specifically, manufacturing grew by 36.8%, EURS by 25.9%, and Europe grew by 25.3%. Digital revenues constitute 62.9% of total revenues and grew by 21.7% year-on-year in constant currency. Core revenue saw another quarter of growth, reflecting the accelerated client focus on cost take-out. Client metrics continue to remain strong with year-on-year increases in client counts across revenue buckets. Number of $50 million clients increased by 15 to 79, number of $200 million clients increased by 5, while number of $300 million clients increased by 3 over the same quarter last year, reflecting our strong ability to mine top clients. During the quarter, we added 134 new clients. Utilization, excluding trainees, reduced to 81.7%, reflecting seasonality and employees joining the bench or position of the training. On-site asset mix remained stable at 24.5%. Quarterly annualized attrition continued to trend downwards and reduced further by another 6% during the quarter. This is the lowest quarterly annualized attrition in the past 7 quarters. Consequently, LTM attrition reduced to 24.3% as compared to 27.1% in Q2. We expect attrition to reduce further in the near-term. Revenue growth was 17.8% in constant currency terms over 9 months FY ‘23. Operating margin for the same period was 21%, in line with the lower end of our full year guidance as called out earlier. Q3 operating margin remained ready at 21.5%. The major components of Q-on-Q margin movement as follows: There were tailwinds of approximately 40 basis points due to benefits from rupee depreciation and cross currency offset by lower benefits from revenue hedging, 70 basis points from lower cost – from cost optimization, including lower subcon. This was offset by headwinds of 30 basis points from higher SG&A and the balance 80 basis points due to seasonal weakness in operating parameters, higher third-party costs, furloughs etcetera. Q3 EPS grew by 13.4% in rupee terms on a year-on-year basis. DSO increased by 3 days sequentially to 68 reflecting higher billing during the quarter. Our balance sheet continues to remain strong and debt-free. ROE increased by 2.2% year-on-year to 32.6%. Free cash flow for the quarter was $576 million, a conversion of 72% of net profit. However, YTD FCF was $1.8 billion, which is implying a conversion of 81% of net profits. Yield on cash balances increased to 6.3% in Q3. Q3 marked the 30th consecutive quarter of delivering positive ForEx income despite the volatile currency environment. Consolidated cash and investments declined from $4.79 billion last quarter to $3.91 billion, consequent to $1.32 billion we returned to investors towards interim dividend and buyback. We initiated the buyback on December 7 and till date have bought back 31.3 million shares worth INR4,790 crores or 51.5% of the total authorization of INR9,300 crores at an average price of approximately INR1,531 per share compared to the maximum buyback price of INR1,850 per share. Coming to segment performance. We signed 32 large deals in Q3, which is the highest ever. TCV was $3.3 billion, the highest in the last eight quarters, with 36% net new. 7 large deals were in retail, 6 deals in financial services and communications, 5 each in EURS and manufacturing, 2 in life sciences and 1 in high-tech. Region wise, this was split by 25 in the Americas, 5 in Europe and 2 in the rest of the world. Growth in financial services was impacted due to a higher than normal furloughs and some specific project closures. These pipelines continue to be strong and oriented towards cost takeout and take of transformation. Our competitive position in the industry as demonstrated in the past remains very strong. Retailers are seeing uncertainty on consumer spending as a result of high inflation, high interest rates and softer economy. However, at the same time, direct-to-consumer and digital commerce are opening up many new opportunities on the back of our growing presence in leading e-commerce platforms and also our very own Infosys Equinox. We have healthy deal flow in the communications segment, along with continued steady pipeline. However, cost pressures and economic concerns continue on the client side impacting discretionary budgets. Energy utility resources and services segment reported strong growth along with healthy level of large deal wins in the quarter. The deal pipeline is strong and an increasing trend versus the previous quarter given medium-term growth visibility. Manufacturing segment continues to be robust, supported by healthy pipeline of deals in both traditional and new technology areas. We are helping clients across engineering, IoT, supply chain cloud ERP and digital transformation, including helping clients accelerate their journey to the cloud. We continue to see caution around budget and spending for consumers in the high-tech segment, especially around discretionary spend areas. For digital service capabilities in quarter three, we have been ranked as leader in 7 ratings for our cloud services, digital engineering services and sales force implementation services. We have also been positioned as a major player in 7 ratings for our IoT and engineering, security and automation services. We believe our structural lever for medium to long-term growth for the industry remains intact and Infosys is well positioned to support its customers in their transformation journey. With strong revenue performance in the first 9 months of the year, the revenue guidance for FY ‘23 has changed from 16% to 16.5%. Operating margin guidance band remains at 21% to 22% for the year. And as mentioned previously, we expect to be at the lower end of the range. Thank you very much. [Operator Instructions] The first question is from the line of Moshe Katri from Wedbush Securities. Please go ahead. It looks like Mr. Katri’s line is dropped. In the meanwhile, we will move to our next question, that’s from the line of Nitin Padmanabhan from Investec. Please go ahead. Yes. Hi, good evening and thank you for the opportunity. My question was around the increase in cost of software packages that’s up by almost $69 million sequentially. How should we think of this cost? Do you think this incremental $69 million will be a sticky number out there or do you think it’s sort of representing the headwind instead of come off going forward? And is this sort of a pass-through nature that’s the second sort of clarification on the same thing? Thank you. Yes, Nitin. So I think these – the $69 million is a combination of software and other deals which we do which have DAS services, etcetera. It could be infrastructure. So these are part of our integrated services offering, right. So these come with manpower component and sometimes they also come with an attachment of these services. So that’s the way we do it. It’s an integral part of our service offering. And I think looking at we have to see where we end up for the quarter four, but I think this is part of our overall offering and it’s actually giving us traction in the market in many of our service lines. Sure. Is this sort of – so it is a pass-through in nature in a way, is that correct? And basically, at least earlier in the past, you had suggested that the new level would sort of sustain. So in the new operating model, this is sort of sticky thing that continues, is that correct? An integrated offering, like I said, this is integrated with our services offering. So they are not just standalone deals we do, they come with the service element as well, right. So that’s the way you have to look at these deals. Hi, good evening. Thank you. Why don’t you just clarify some comments around demand? I am curious if you would say there is a material change in the way that clients are behaving now versus 3 months ago in your reported 2Q, because the areas you are citing weakness I think were the same ones, the pockets of weakness that you talked about. I am really just trying to understand if you think there has been a real change to spending and contracting there or more broadly the same? Hi, thanks for the question. This is Salil. What we have seen today in addition to what we said last quarter, for example, in financial services beyond mortgages, we see the investment banking side of our clients as well showing an impact of the economic environment and they are in telco, high-tech and retail in some clients. So, we don’t see a material change, but within financial services, one more area that we see some of the impact coming in. Having said that, we have for example clients in energy or utilities or manufacturing, those industries are still looking quite strong in terms of the outlook. Okay. Okay, that’s helpful. And then on the large deals, the renewals were a big component of that TCV and you have also cited benefits from consolidation in the commentary, are you taking any different approach as it relates to proactive renewals to try to drive more vendor consolidation opportunities? So on large deals, as you pointed out, we have had a very strong result, $3.3 billion and 32 deals. We see the focus which we had on transformation continue, but outside of the industries that we discussed before, where there is some impact, we see huge cost automation, cost efficiency plays across all industry segments. And there, we have, we believe, very strong capability, which is helping us. And within all of those discussions, we see areas where there is vendor consolidation. The approach we put in place is similar to what we had in the past. However, we see – given our market share gain over the last several quarters many clients are looking at us when we start to narrow the list in the vendor consolidation. Good evening. Thank you for taking my question. Salil, I’m not asking for any guidance for ‘24 or ahead, but would appreciate your comments. And then the visibility that you have for the year ahead, so how different would it be versus typically this time of the year. So, perhaps any comments on pipeline or pipeline to TCV conversion? Thanks for the question. I think – as you rightly said, we are not in a position to provide the guidance for the year, which starts in April. Pipeline – we have a very strong large deal pipeline. So we are feeling good that the pipeline is at a level which is in good shape. We see good traction on large deals and we’ve seen more in the sort of relevance connect with our clients on the cost efficiency and automation gains and in the areas, in the industries where there is economic support a good traction of Cobalt and the digital transformation phase. So the pipeline is looking quite good today based on what we see in the digital. Got it. And Salil, you called out IB mortgage in parts of telecom, high-tech and Retail, but is there any vertical trend for these between transformation – the ones that are transformational nature and deals that are more on the cost optimization across verticals. And the second part to that is, do you see any moderation in new client acquisition channel with more vendor consolidation deals happening. This was something which we had very strong traction more recently. On the first part, we see some of the growth transformation plays impacted in those industries that we talked about, for example, mortgage investment banking, retail, high-tech, etcetera. The cost efficiency plays everywhere. So we see that even in programs there and let’s say in the energy sector or manufacturing. There – in many places, we see essentially clients looking to use the cost efficiency to fund the transformation because in many cases, they still need to drive digital or cloud transformation to keep their market growth, so that clients connect, customer connect are going. So that’s how we see that play right now. Yes, there on usual, our new client, we’ve seen – while we don’t disclose the number, we’ve seen a very good new client acquisition in Q3. And then the consolidation of discussions where – so there is no contradiction in there to at least – both are carrying on within our sales expansion, new client acquisition continues to be important as well. Then the consolidation, what we are seeing is on several discussions, clients are looking, especially if they have six or seven vendors they want to narrow down to one or two or three, and we are appearing to the beneficiaries in quite a few of those discussions. Sorry to interrupt, your audio is a bit muffled. If you are on a hand speaker phone, please switch it to handset or something on your phone. Sure. So Salil, I have two questions. First, on the strong TCV wins this quarter. Can you at least let me qualify how much of the strength was on account of share gains, which you guys have made versus the resilience, which is there on the technology spend because if you look at the broader market commentary, and you have also highlighted retail as one of the weaker areas whereas you got seven large deals in retail. So if you can just help us break out these to get a sense of the deals in momentum? So there – I’ll start with that. This is Salil. I think the large deal momentum for us is really a function of what we’ve seen that we’ve put in place, we still within this mix of $3.3 billion have digital transformation deal, and we have cost efficiency automation deals. What we mean by some of the industry callouts, for example, retail or telco is, there are some clients, not everyone in that industry, but there are some clients which are getting impacted by the economic environment. We’ve been quite focused. We have a broader portfolio. So for example, we showed up in retail, we have those large deals and the it’s a mix between transformation and cost efficiency automation. And so many times when clients feel an impact of the economic environment, and there might be a greater need the cost efficiency play as well. So we are ensuring that both of those engines continue to work well with our clients. Right. And my other question was on the margin side. You guided for margins ‘21 to ‘22 bands with margins towards the lower end. Can you just help us maybe what the pools which you are seeing on the profitability given that the supply scenario is in rapidly. Is there some portion of the pressure which is on account of the higher share of cost efficiency deals, which you guys are winning with initial ramp-up cost, because if you look at Q4, obviously, Q3 also had the pass-through business, which got impacted. I’m assuming, as Nilanjan mentioned, there was some seasonality into that. Yes. So I think like we mentioned, the reason for Q3 margins, we’ve already given the breakdown. So as we look ahead to the levers which we have on is of course, utilization, right? And we’ve seen about 1.7. This is probably I think at least in the last 3 to 4 years have been worse in the lowest. So that’s one which we will have. And as we start putting these pressures on to the production floor that you will get a automatically if there any benefits, right. So that will be a double value impact for us. We also have subcons. Today, we dramatically reduced our subcons literally in three quarters. We were 11% plus. We are 8.7%. Historically, we’ve been at 7%. If you look at our pricing has been quite stable and historically, this was one lever which we always bind down repeatedly, which is a discounts and renewals etcetera. And as of now, we haven’t seen that at all. We continue to push with clients and where all we can get price increases. So we are seeing the information in terms of our own workforce continuing to upgrade that and that we ever which we have. So we are continuing to see these are in our era to speak as we look at, and we will continue to deploy them. Is it fair to assume that we should see at least better profitability in the next quarter, given that we have a number of levers in the business? So there is been a guidance for the year. You’ve seen in the first 9 months, and that should give a good indication of Q4. Yes. Good evening, gentlemen. Thanks for the opportunity, and congrats on a good quarter. Salil during some of the previous macro uncertainties like Brexit, with in a few weeks of the vote, we had seen some of our large clients canceling the ramping down projects. This time, even on the tough comps, the pace of growth in moderation is much lower than what many people have been anticipating. And many forward-looking indicators like deal wins, pipeline and CIO surveys still continue to be very strong. even 11, 12 months into this macro concerns. So are you seeing the previous three to four macro downturns? How do you move on to the current cycle, especially on the available of the resilience of IT service spend? So thanks for the question. It’s always difficult to sort of compare across cycles. From the perspective of Infosys, my sense is what you mentioned earlier, which is we are still seeing the pace of change when there is change within an industry or client to be not rapid. And we are also seeing that the opportunities for cost optimization and efficiency are expanding within the work that we are doing. So in many ways, we are in a good position to be able to work on both sides. And so – while it’s difficult to predict what the the situation in the economy will evolve, we feel quite balanced. Our sales team is quite agile we’ve pivoted quite quickly and develop various sort of points of view on different efficiency scenarios in different industry that we feel comfortable that the pipeline will be is looking good at this pace, and we will continue to work on that. Sure. Thanks, Salil. So is it a right understanding to say that we are now in a much better position to navigate this macro weakness probably through more than compensation from the cost efficiency deal and vendor consolidation deal. Is that the correct interpretation? The word we see it is we have both components of at least the two large components of our clients are looking for we have good industry-leading capability. So it’s really a function of a specific industry, if industry or a client will evolve, the position ourselves to make sure that we can support our clients in that area. Hey, thank you. And happy new year, and congrats on strong execution in a pretty tough environment. I have a three-part question first, March guidance upgrades is pretty unusual from a seasonality perspective and given the macro concerns. So it seems like you have better visibility now. Can you share any views on the budget cycle itself, your kind of concern over slippages, maybe a month or 2, budget delays. Are you seeing any of that? Or you think the budgets will be awarded or finalized as on time this time? Thanks, Moshe. This is Salil. On the budget, so far, we’ve seen in some clients and especially in the industries we’ve called out some areas where there has been slowness in deciding or some sort of changes, especially on some discretionary work. So we mentioned high-tech, for example, mortgages, a bank – investment banking. So all of those ones that we mentioned before. But we don’t see a broad base change. Equally, we do see good, let’s say, the area with the budgets moving ahead as in the past, with energy, utilities, manufacturing. So we’ve got like one answer that it’s a little bit by industry or sub industry somewhat different. Understood. And then you – in the press conference, you mentioned that about third of your new – third of TCV came in from new logos. Can you remind us, is this within the range of what you’ve seen in the past in terms of mix of new logos versus renewals? Sorry, referring the last deal, $3.3 billion that was 36% net new. That in the range where we do some quarters its lower, some quarters higher, but not – these numbers are not unusual. Okay. And then the final question is for Nilanjan, when we met in Bangalore back in December, you pointed to pivot in the nature of the new deal flow towards, as we said, cost optimizations and your consolidation. Obviously, this is what you’re seeing. Are these deals typically less dependent on clients’ budgets given the fact that you’re kind of taking over a specific function with the objective of kind of reducing delivery costs? And is there any difference in profitability levels here in terms of these projects versus some of these projects that you’ve been doing in the past few years? Thank you. So in that, I think the way you described it, these are not fully correlated with the budget of a client in many instances these are areas where given the evolving economic situation, clients are looking to reduce that tech spend across the enterprise, in many cases, use some of that savings to fund transformation programs. It sometimes was coupled with vendor consolidation. So let’s – there are clients you may have five or six vendors and when we benefit from the consolidation we see tremendous efficiency that can be created. Our automation tools become quite useful. We typically add automation on our ongoing programs, which gives an annual benefit. But when we see something of scale where we have not been involved earlier, we have an ability to provide a much greater benefit. In aggregate, the profitability of these deals is within the range of the rest of our company and especially has been more and more over time, leverage the automation tools and our capabilities, we see these becoming stable high profit deals. Yes. Hi. Thanks for the opportunity. So, my first question is on the smaller deals, which are less than, say, 50 million TCV. If you can give some qualitative color on how your win and pipeline in that basket has been moving? Is it higher, lower versus, say, what it was six months back? So, on that – thanks for the question. We don’t typically disclose much about those deals. Overall, we have a good healthy pipeline where we publicly disclose more about the larger deals. Understood. And Salil my second question is on these cost takeout deals. Can you give some sense on how the pricing in such deals behaving? Are you seeing the pressure there more than normal, either because clients are pushing for more discounts or because of competitive intensity? So, there the pricing in Q3, we have seen quite stable within the mix, we have not seen a change. Typically, it’s really a function of what type of focus that clients have, which industry they are in, as we have not seen at least in Q3 in the deals that we have closed in the discussion. We have a big change on that it looks stable at this stage. Hey. Thank you and congrats on the strong numbers there. Just a couple of questions to understand some little bit better. I think one of the comments that you made earlier on the Pankaj’s question, you mentioned on previous calls over the last year, the listed deals what were [ph] smaller deals and that is showing up and so despite headline deeply declining. Ankur, we can’t – we couldn’t hear. Ankur, we would have to go on a handset or something. We couldn’t hear your voice is very muffled. Okay. Thank you. So, I was saying that I am going to try and counter this question in a different way. You had mentioned in previous calls that the mix of deals was changing in favor of smaller deals. And that’s why the headline, TCV was declining, the growth is still quite healthy [indiscernible], do you think the mix of deals is still the same as it was in the last year before this quarter? Hi Ankur. Thanks. This is Salil. I am not clear on the mix of deals on the previous discussions. But just looking macro, we see the mix of deals remaining in good shape across the board. There are some quarters in which – those were number of larger size deals. But in general, we don’t have a pattern in that, at least that we did in Q3. Okay. Alright. The next question I wanted to check, Salil, again, was on the U.S. business. The headline growth seems to sort of slipped down to close to low-double digits, whereas the growth has been led by very strong performance in Europe and manufacturing. Do you worry about the U.S. business, it’s sort of slower than Europe, which is not the case in the rest of the industry when you look at deals? So, there, Ankur, we have had very strong growth in the U.S. at over 10% in Q3 in constant currency. Europe, of course, has been a standout in the growth that we have had. We see the traction, the pipeline, the work remains pretty strong, as we have described earlier, across the two dimensions transformation and cost across the geographies. If you look at the economic situation, we do see developing side a little more impacted, but we see good traction on the pipeline in both. We had a very successful Europe program in the last 18 months, 24 months, and that’s also helping us with the growth in this quarter. I mean out of our large deals this quarter, 25 were actually medical. So, I think this will show that we have a very strong pipeline there. Understood. Maybe a last question over here was on pricing and contract profitability in the projects you are winning right now, especially the large number of big deals this time you signed. How is that trending? Is that improving, staying the same or maybe becoming a bit lower than before? I don’t think there is an unusual. Yes, absolutely new deals, and in fact many clients want the productivity efficiencies upfront. So, we always see that the – initially, part of these new deals will be lower than portfolio margins. But like we have shown in the past, at the same time, our existing deals and large deals are reaching higher profitability, and that offset some of this pressure which is coming from the newly signed deals and margins will typically be lower. So, that is unusual on the trend. Hello. Yes. Hi. Thanks for taking my question and congrats on a solid quarter. So, Salil my question – I have just two questions. One, I wanted to basically get an idea on, I mean you have seen attrition coming down in this quarter quite sharply. And as you mentioned in your opening remarks as well, so I mean how do you see the trend of this attrition going forward of course downward? And how do you believe the benefit of this could actually percolate to our margins? Again, I am not asking for objective guidance of a number. But in terms of the direction, do you think it is going to aid our margins, or do you think most of the impact of this is already built into the numbers that we have currently? And my second question was usually on the geography of Europe. So, just wanted to pick a win on how the conversations with the clients are happening in that part of geography, specifically if you could maybe break up between Continental Europe, Eastern Europe and in the UK. And which pockets of those geographies do you think are looking more softer, or is there more of believe looking in that part of the geography? So, I will take the first one on the lower attrition. Absolutely, we are seeing this coming down. And like we have said, even in the future in the next quarter, at least until, what was an issue, because we are seeing is coming down. Absolutely, this should have a positive impact on margins. I mean during the year, whether it was stretching on laterals, whether it was the compensation hikes we did, that really impacted our year-on-year margins. So, I was looking ahead and attrition as an impact both of the macroeconomic and also the internal policies we are doing in terms of promoting within, etcetera, should benefit us looking ahead. On Europe, I think the way we see some color for 25% of our business in Europe, and we have a few countries in the country, we operate in we see some slowing – some economic impact in Germany. There is some in the UK, less so in the moderate countries at this stage. But overall, the coloring is a little bit more by the industries that we mentioned earlier in the call, which are across sort of on a global perspective. But relatively, Europe seems a little bit more impacted today than U.S. Got it. If I can just maybe drill down just a little bit more. Any specific color that you can provide on European retail and European manufacturing segments? So, there – we don’t necessarily provide that much sort of granularity, but sort of same comments on a global level on manufacturing that we mentioned earlier and for energy, which is looking stronger and sort of let’s say, attention to the economy on retail in this case. Got it. And the softness in retail, do you believe it is as of now confined to the retail stores and what maybe circulate and you could, in your discussion with clients, do you see percolating down to the CPG companies and probably other ones as well. But as of now, if you look at the more of the retail stores that we are talking about? So, within retail, we have not called out any specific sub-segment at least in our commentary. We are not gone down to that rightly in our public statements. Thanks. Just one question around outlook, if you look at your commentary around readings in North America and Europe, you don’t look more cautious overall, but if I look at performance for the last few quarters, I think Europe has been performing better than North America. So, do you think this impact of the cautiousness and your tools it looks like [indiscernible] and you see more growth trajectory will be a little more affected going forward, your thoughts around that? Thanks. I think in Europe, there is two different things. We have had a very strong Europe program, both in transformation and cost over the last 18 months, 24 months. So, some of that comes through in the benefits we see even in this quarter. The commentary or the view is more to share what we are seeing just in the economic activity. And again, we see the coloring more by industry, which is a little bit global as opposed to just specifically across the board in the geography. So, the outlook, I mean do you think the outlook that you are giving will reflect in the numbers in the last two quarters I mean because [indiscernible] has been an unforeseen portfolio. Thanks. So, there we have given a view on our outlook only up until March this year, so we will come up with guidance for the next financial year at the end of this quarter. Thank you. Our next question is from the line of Girish Pai from Nirmal Bang Equities. Please go ahead. Mr. Girish Pai, could you please un-mute and go ahead with your question. As there is no response from this connection, we will move to our next question, that’s from the line of Rahul Jain from Dolat Capital. Please go ahead. Yes. Hi. Thanks for the opportunity. Firstly, we commented that manufacturing is doing well for us, but actually the vertical is doing exceedingly well in the European region, that is up 60% YoY, but is much weaker in the U.S. where it’s up 7% YoY. So, what is that we are doing so well in Europe, is it a lot about few very crucial deal, or it’s more holistic and why it’s different in the U.S.? So, thanks for the question. Within the industry, we don’t typically comment on a client, multi-client level activity. But we do have good traction, as you pointed out, within our European business in manufacture. Okay. And another thing was on digital revenue. For the quarter, it’s up 17% YoY or let’s say, CC would be 20% or 21%. This is like our slowest ever since we have been giving this time savings on digital revenue. So, is this a bit worrying, or is it more because of the furlough and any other factor? So, it’s partially due to some of the changes that we were discussing earlier on in certain industries and sub-industries, we see much more attention to the economic environment. And the – we see some of the digital transformation work being slower where we see much more focus across the board on the cost and automation. Got it. And lastly, if I can, is margin impact furlough was too high in the quarter. How has this shaped up in the current month? Are these clients resume to normal scenario or that will remain extended in Q4 as well? So, we will have to see how it goes, it’s a bit too early to say what’s going to be the Q4 outlook on that. Yes. Thank you. I just wanted to understand with cost optimization deals more in the pipeline and in the TCV, has the average deal tenure gone up in the last couple of quarters? Okay. Can you say that the third-party, I think have given you a lot of traction in terms of getting deals. Now, the number has gone up from about less than 2% of revenue to almost like – I think this quarter it’s – in this quarter, it comes to almost like 6.5% of revenue. Do you see this number going up in the coming quarters and years? Like I have said, we are offering it quite holistic. In some cases, like I said, many of the cloud-based deals come with services, there could be licenses, there could be DAS services. So, more and more integrated deals and then you go to IT-as-a-service, which is really sort of very holistic. We could see this. But I mean it may vary from quarter-to-quarter, you could have some quarters with that. But there is nothing to say that in the long run where this is going a bit early to say that. Okay. And lastly, from a competitive landscape perspective in the vendor consolidation deal, who are the ones moving out? Are these the global MNCs or these are typically Tier 2 vendors? Again, on those, we don’t specifically comment on where we are getting the benefit of the consolidation. We are seeing some benefits coming through with large clients. Thank you. Ladies and gentlemen, that was the last question. I will now hand the conference back to the management for closing comments. Thank you. So, thank you everyone for joining us. This is really fantastic to have our Q3 close out, 13.7% growth, 21.5% operating margin, 3.3 billion in large deals, very happy with that outcome. We can see guidance increase on our growth for that. And we can see both sides of our business on transformation, digital work and core services, cost automation working well. And so we feel good with the current environment and how we can play and support our clients on both sides. Thank you all for joining us and we look forward to catching up during the quarter. Thank you. Thank you. Ladies and gentlemen, on behalf of Infosys Limited, that concludes this conference. 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EarningCall_1424
Well, good morning, and welcome to Citi's 2023 Communications, Media & Entertainment Conference. For those of you I haven't met, I'm Mike Rollins, and I cover communication services and infrastructure for Citi. Since this is our first keynote, let me also take the opportunity to wish you a Happy New Year, and thank you for joining us for our conference today. Before we get started, I'd like to mention that we do have disclosures available at the registration desk, and at Citi Velocity page from which you're streaming the audio. We're also going to work to incorporate your questions into today's session. If you're streaming this connection, there should be a question box on the page for you to ask questions. And we do have a microphone, if we have time today, to try to get it around the room. And finally, continuing on the tradition of using our live surveys, they're completely anonymous; we're not tracking responses; we're just aggregating the results. You can access the live poll and Q&A both with the codes that are up here and there's placards around. I'd just encourage you to log in now, so you can get ready to respond to some of our -- well, I hope there're going to be some really good survey questions. And it's also available on the streaming site as well. So, with that out of the way, I'd like to welcome back Hans Vestberg, Chairman and CEO of Verizon; and Kyle Malady, President of Global Networks and Technology. Hans, Kyle, thank you both for joining today. Well, so we turned the calendar to the New Year; it only seems like a couple of days ago. So, as you're now thinking about the year to come, can you just give us a high-level perspective of the strategy, the priorities? And are there any notable changes in your objectives from the past year? First of all, we need to announce the Safe Harbor statements. Anything that Kyle might say, it might be forward-looking, and rest from me as well, so those of you aren't aware of that. If you look into '23, I think a couple of things we are changing. So, Kyle might talk a little bit about that technology that is actually changing going into '23 compared to the previous five, six years, so I'll let him talk about that. When it comes to the other businesses, I think that, first of all, the mobility, and especially on the consumer side, we have done quite a lot the last two quarters. As many of you know, we are -- I was not really happy with our performance at the end of the first quarter, and, of course, then that trickled into the second quarter. We [started] (ph) to take actions in the third quarter being a bit more agile, moving to the softer segments that we had, we continued that work in the fourth quarter. So, you're going to see us being more agile. You're going to see us being even more focused in certain segments. Remember now, we're all the way from the Lifeline with the TracFone brands, all the way up to the premium brands, we're actually covering all the consumer segments. Our job is going to be even do smarter, more surgical actions in the different segments to see that we retain our customers, but also acquire the customers that we want to have, ultimately with the goal of cash generation. That's number one for us. And then, we really think that is super important with wireless revenue growth or wireless service revenue growth and EBITDA expansion or cash flow expansion, that's really where it boils down. So, you're going to see us be more on that side. Then I think a couple of other things that already has started emerging in '22. I mean, the national broadband, of course, both with Fios and fixed wireless access, is really doing well for us. That's the strategy we outlined five years ago. It's starting to bearing fruit right now. In the third quarter, you might remember, we had way over 300,000 new net adds on broadband. We continued with a good journey in the fourth quarter. Of course, I'm going to disclose the numbers when we meet in three weeks from now, but feel really good about that. And finally, we started getting attraction. We talked about private 5G networks, mobile edge compute, maybe the deals are small, but this year, we're going to use -- get a lot of deals and that's going to be a great base for our sort of platform for us to grow with enterprise customers over time. So, I think we have a strategy, but we're actually tweaking a little bit, being more surgical. I think, as I said, when we kicked off last year, we have all the assets. We have now this -- the spectrum, we have the network, we have built the network for five years, we have TracFone, we actually divested Verizon Media groups. So, we're much cleaner in what we're doing. And on top of that, you're going to see us doing more cost efforts this year; we announced it in third quarter. So, yes, it's a quite a lot of differences we're doing this year, but the core strategy is the same, it's more how we tweak it and go faster in certain areas, and actually change a little bit focus in certain areas. Yes. So, consistent with what Hans says here, we're going to -- we're tweaking our build a little bit. So, for the last bunch of years, we've been building a lot of fiber, outside of our footprint, as well as inside of our footprint. We've also been really bolstering our core network to handle massive amounts of data in the course. And then, focused a lot on millimeter wave builder. All three of those things are starting to come to the end of the build process, if you will, right? So, in our One Fiber markets, we are roughly 80% done with our core builds there. So, now it's just a matter of hooking things up to it. Our millimeter wave, we're over 40,000 nodes. And now that millimeter wave technology turns into a tool for RF engineers to use in hotspots that they have. And C-band, so we continue to build the C-band out. But the three major programs coming down and C-band still continuing to roll allows us to take CapEx out of our program overall. So, we're going to be less CapEx-intensive going forward. Then the other thing that -- the tweak -- the other major tweak that we're making, and Hans said, is getting -- we're getting more local. When we were doing all this build, it was -- we consolidated a lot of things, so we could bring a lot of scale. Now, it's really about optimizing. And so, we're having a -- we have a close focus at the local level along with our sales counterparts in the BU to make sure we're taking care of issues at a local level and servicing the customers in that way. And you can say also that, on the consumer side, as I'm also running the consumer business, we are doing the same thing. We are in a moment right now when we go more local with our -- and executing more locally, both with branding, marketing, but also executing hand-in-hand with our team in technology. So, this is a pivot for the next step for us. It's been centralized for a while. And now we go local, as the network has come so far with the coverage. We're now more in revenue optimization, capacity enhancements, and we have built everything, as Kyle said, from the data center to the edge were built now with fiber redundancy, multi-array edge routers, and now at the edge, we can decide what type of business we're doing with different type of customers. I think this was a dream that I had when I started at Verizon in 2017. We two drove up this Verizon Intelligent Edge Network, and now we're there, and that's why we're also going to see quite dramatic reduction on CapEx. And it's not because we're not doing everything we want to do, it's just that we have now built this. We still going to have in 2023 a piece left of the $10 billion that we have added when we bought the C-band in CapEx. But ultimately, we're not coming down to BAU, that is pre-2015, 2014 levels in absolute number, and '24, we should be done with that, so we only have BAU. So, clearly, this has been a strategy for a long time. We have the best network. It is just going to get better with the work we're doing. And later this year, we're going to get all the spectrum we need; 160 megahertz on C-band, covering the whole nation. And in the first quarter, Kyle has not only promised, he has guaranteed, we're going to pass 200 million PoPs on the C-band as well. Isn't that right, Kyle? And just maybe finishing a topic on the BAU CapEx. So, the goal -- remind us, the goal for 2024 BAU CapEx is? Around $17 billion, somewhere there. That's where we're aiming for. It could be $17.5 billion or something. But around that number is BAU that probably is going to be the lowest capital intensity in the industry in the world when it comes to divided by the revenue. And again, we have built a network that is so smart. That was the whole intention from the beginning. That will, of course, unleash capital for us and cash flow. Again remember, what we are measured on ourselves is the service revenue and the cash flow. That's really -- and especially going into this year, it's going to be even more important for us. And so, maybe just rounding out one more part of the discussion on this, while we're just talking about CapEx and investment, what are the things that could cause you to want to spend more than BAU CapEx in the future? Is it to go more fixed wireless, bigger, broader? Is it more fiber? Are there things that are on the whiteboard somewhere where, "Okay, here's BAU, but here are things that we should just be mindful of that you might do in the future?" It would be something like when we did when we bought the C-band, it has to be something that's very clear to the market why we're increasing. I think we have discussed this every time and I will have Kyle helping me out here. But we have talked about the 4 million to 5 million fixed wireless access broadband customers as a goalpost for us. The network will handle. That we build it once, we'll use it once. There might be many, many years out a conversation when, "Hey, do we split sales, and do unique fixed wireless access solutions?" That's not in the plans for the next four or five years. But after that, it might be that we come back and say, "Hey, it's a great opportunity. We split 10 sales here, because we can get more subscribes." I think that's going to be a great conversation. And it's going to be sort of success-based fixed wireless access as we do Fios today. Right, it'd be -- I think it'd be opportunistic, right? I mean, like we did last year, remember, we spent some money, and we opened up 30 more markets for C-band to past the 46 that we had. We were able to invest and clear those quickly, so now we have those launched. So, between now and when we get the full cadre of spectrum, if there's some opportunities like that, that allow us to accelerate and grab revenue quicker, then that's something that we'd absolutely look at; just like we do with Fios. So, we'll jump into the consumer business in just a moment. But let's queue up our first survey question. So, the first live survey question [Multiple Speakers] Yes, you guys are… You get to vote, yes. So, we can get a placard up here. It's right up here, you can log in. And it should be visible now on our streaming site as well. I already see responses starting to come in. So, the question is, what do you expect for Verizon's postpaid phone net adds in 2023? And the choices are: less than equal to zero; over zero to 500,000; over 500,000 to 1 million; and over 1 million. So, we're going to get those responses coming in. We're going to start talking about consumer. We'll get back to the results. So, Hans, you've taken over consumer recently. What can investors expect from your leadership of consumer? And what are the changes you trying to solve for? Ultimately, what's the end goal of these changes? I think, a couple of things, which we already have seen coming into the market. We will, first of all, from a offering point of view, we will be much more segmented to go for segments that we see that we're not performing well. And you have seen the Welcome 30, the Welcome 25, coming out with Bring Your Own Device special offering in a segment of the postpaid segments. The other thing we're going to see is also harmonization more on the operations between the network and between the consumer business. And you also will see us combining our consumer investment. When I say consumer investment, it is everything from media to above-the-line promotions, below-the-line retention. And we're going to be much quicker on using that money instead of locking it up for longer times, because the consumer sentiment has changed a little bit. So, it's going much faster for them to change. We have been a little bit slow in some of those areas. So, now we combine all that money in order to be quicker. Actually, we saw in the fourth quarter, for example, we use a little bit more to media than we're actually with the spend, because it was smarter than using in promos. And that is what you're going to see from us, much more agile decision-making, using the regionalization right now, and being closer to the markets, and having actually decision taken little bit lower down in organization. That's what you're going to see from us. But you can bet that we will be discipline. We're going to be focused on our cash flow and see that we get the right customers. We're not going to throw ourselves after the net adds that is not giving us the right quality and the right return on investments. That's not the main goal here. The main goal is service revenue. ARPA growth is very important for us. You saw in the third quarter how much we grew on that. That's important to us, and that is creating bottom-line, at the same time taking out costs, so we get leverage on our scale. And don't forget when you answer the question, which you've already done, our business side is doing pretty well. We have six consecutive quarters or five consecutive quarters over 150,000 subscribers, and they continue well. So, we're taking there. So, it's more about where do I take my subscribers? Where are they giving my best return on investment? That's one process for us. Kyle is working a lot with me right now on the operation with stores and how we plan with incentives. You'd say commissions, but I think it's the same thing. Yes. In the stores and how we are tweaking that up, harmonizing it with overall. So, that's what you're going to see from me leading the consumer business, together with guys like Kyle and, of course, the existing management team of consumer. And as you look at the fourth quarter promotional environment, can you frame what you saw? Verizon had a goal of getting back to positive in consumer. How do you do? And is there a significant amount of spillover? You raised the whole issue of iPhone inventory. Is there going to be a spillover from 4Q to 1Q? So, when it comes to the consumer net adds, I was just going to say one thing, we were positive. I'm not going to go into the details, because I have my earnings call, but we were positive in the fourth quarter. As we said, we should be, team did a good work. When it comes to the promotional environment, it's always a little bit elevated for the holiday season, so that's nothing. But it was nothing unusually higher this time. We tried to, as usual, be as disciplined as we grow, then go into certain segments. There were some choppiness in supply from one OEM, which you probably know who it is. But they sorted out. So, there's basically no spillover right now, at least for us. We had a good supply. We had a good collaboration with OEMs. There were days that were with complicated lead times, but we sorted that out, it was a very short time. So, yes, it was good. Let's go to the results of the survey. And we've gotten some good response rates here. So, I'll read you the percentages and the answers. And for those online, you could see the graph there. So, 15%, less than or equal to zero. This is for postpaid phone net adds in 2023. 65%, zero to 500,000. 21%, over 500 to 1 million. And zero was over 1 million. So, how do you think about these -- the response from our clients? Yes. I don't know what should I say, their vote. My focus, again, is going to be generating service revenue growth, that's going to be the number one. One measurement is, of course, getting new customers, but you can step up, you can do -- remember, we have talked about this so many times, our job -- when we ended the third quarter, we had 41% of our customers on -- in postpaid on unlimited premium. I mean, every step up that we would do every quarter with 2%, that's far more important from an ROIC point of view, than actually taking a new net adds. Can you just make the calculation? And you do them all the time. You know how much it costs the new net adds with promos and compared to do a step-up. So, again, you need to be smart in a market where it's a subscription-based model, that's what we have in front of us. It's one of the best subscription models in the world. You need to be smart how you spend your money. Are you putting it on promos to get net adds? Are you doing for retention? Or are you doing it for step-ups? All the time, be more surgical. It's a financial game here. I know that some are very focused on the net adds, as the main driver, it's not the main driver, necessarily. It's one driver. So, I think that's going to -- you're going to see from us. So, I think the response are great guys. We're going to see where we end up. Let's go to our second survey, and then we're going to come back and talk about the network while we get the responses. So, second question, we're going to ask our audience. Does Verizon need to reduce wireless postpaid service pricing at the risk of ARPU to improve volume growths? And your choices are: no; yes; and maybe, but tearing and upselling can offset the base pricing changes. So, we're going to -- let our audience respond to that. Kyle, coming back to you for a moment. In terms of network performance, can you talk about what you're seeing with the use of mid-band 5G? And is there a clear difference in usage and customer growth in the markets that have the C-band versus the markets that don't have the C-band? We're getting great feedback on the performance of our C-band. I mean, for me, being in the industry for such a long-time and just having the ability the Board given us the wherewithal to obtain the spectrum that we actually call, as generational spectrum, and we've never been able to put this amount of spectrum in play for our customers, and the uptake has been great. Our usage growth in the markets that we have C-band is up quite a lot. And to the point now where C-band usage overall is 15% to 20% of our overall usage, and we only have it going in 46% of our markets. So, we see average users using it more when they have Ultra Wideband, and we're getting great feedback on it. So, the other thing that's really unique about it, is really the C-band that we're putting in play now as opposed to LTE and low-band spectrum, which is just for mobility, this spectrum swath is really mixed use, right? So, we're doing both home and mobility in it, as well as millimeter wave, we're treating it the same way. So, all of our Ultra Wideband spectrum is being used for both. We're seeing just what we expected, frankly, in terms of fixed wireless access usage and have it -- it is more than the traditional mobile customer. But also, the time of day when people use it the most is offset. So, we feel from an engineering perspective, we're doing a good job fully utilizing the asset. And I'm just frankly -- I'm really excited that also the Board gave us the wherewithal to get the new 30 markets up and running quicker. We're going to be really aggressive this year, bringing more and more online, and then I just can't wait till we can turn the switch on, I guess, would be January 1st next year, when we can bring the full complement of the C-band to bear. But, right now, we couldn't be any happier with how this is going. And just adding to that from a consumer point of view, we see a great pickup on step-ups and things like that in a market where we have the C-band deployed. And remember, we only have 30 plus 42, 72 markets I think, that has the C-band today, of course, are populated because they're going to pass 200 million. But there's 402 markets where we have the spectrum. So, there is plenty of markets left to be done, and that's also when you see our -- SKU on our fixed wireless access is much more on urban and sub-urban, because that's where we deploy C-band right now. But, of course over time, and not too far away, we're going to have also C-band in some places more than 200 megahertz. And so -- and we see actually the correlation there. So -- and then finally, I think, everything that Kyle has built right now, we are prepared just to hang the radios, meaning, we don't need to go out there again adding 40 more megahertz or 60 megahertz, we have prepared them in places, even prepared for 200 megahertz where we need 200 megahertz. And we'll come back to the step-up point in a moment on the ARPU side. But let's get to the survey results and share what we saw from our audience perspective on, does Verizon need to reduce wireless postpaid service pricing at the risk of ARPU to improve volume growth? 28% said no; 41%, yes; and 31% maybe, but up-tiering and upselling can offset pricing changes. So, Hans, you mentioned earlier the importance of wireless service revenue growth. Can you talk about how Verizon is charting the path forward with the volume, with the ARPU up-tiering that you're doing? And how price comes into play in terms of the competitive landscape? I think that my answer would be, no. But when we go into segment, in certain areas, we might be a little bit softer and we need to have more competitive offerings, and we're going to have it. But we still going to preserve our premium and we want to preserve the growth of our service revenue. So -- and remember, sometimes we talk only about consumer, but we have over 45% market share on the business-to-business and wireless as well. So, we work the whole system constantly to have the right pricing. But very clearly, we're going to continue to see that we have premium brands. And remember we have different type of churns in different segments of the market, where we don't need to do much, others we need to do much. Usually, we have high churn in the higher segments. In the lower postpaid, we're being a little bit softer, that's where we need to do plans like we did right now with the Welcome 25, for example, which is Bring Your Own Device, see that you get away from the promotions. So, again, think about the consumer investments again. You take money from the promo and you can actually do it on something else and the return on investment is better, and the lifetime cycle of the customers is even better. And then, the churn is improving as well. So, you just need be surgical. But saying that we're going to do price reduction across the border, I mean, that I think is just irresponsible and not really thinking about business you're running. And we don't need to do it, but there are areas we need to be better for sure. And we will be aggressive in those. We kind come in in a market and go out in a market in certain places, we're going to continue with doing that as well. So, I think that's going to be our strategy and that you're going to see us be more agile and more sort of surgical in that. And in terms of the step-up opportunity and ARPU, can you frame where the base is today on the premium plans? And what you're seeing in terms of the mix -- in terms of where that destination of mix of up-tier maybe? Yes. So, we are, as I said, on Unlimited Premium, 41% during the third quarter. In average, we have been adding 1 percentage points to 2 percentage points every quarter of more customers on that one. So, still a big portion of our overall consumer base is there. On the unlimited, of course, that is now getting up to high 80%-s -- or high 70%-s, 80%-s. But we still have more to be there -- going there from the metered plans, and customer usually love to go from metered to unlimited. So, there's both those steps. And all steps for every percentage we move is creating service revenue growth. That's how it works. So, that's what we will work with, but we're going to need to have compelling offerings in some of the high premium plans like the Unlimited Premium. We include Disney Plus and things like that, because customers really like it. And we have owners' economics of that, because, ultimately, we give the distribution channel to Disney. Oh my god, the guy is a [nightmare] (ph). We're using our distribution channel as a scale and then we can also make money on that one. So that hangs together for us. We will continue with that. There are certain segments, I don't care for an inclusion, and we shouldn't give them that. And our next step is, of course, Plus Play, where we can have a much broader base, not doing inclusion, but the customer can use it. So that's the next step we'll have of it. So, I think we have a lot in the toolbox to really work with decent segments. And Verizon touches so many aspects of the economy, the consumer side, the business side. Are you seeing any changes in behavior in terms of spending patterns, payment patterns, or even up-tiering where you're seeing any signs of change in the economic climate? Yes, we cover a big portion of the consumer market. I cannot speak for my competition, so I speak for about myself right now. We have seen increased store traffic from the second quarter to third quarter, third quarter to fourth quarter. It might have been that we had some challenge to ourselves in the second quarter, so that was more ourself creating less store traffic, but we clearly have seen that. The other thing we have seen is, during the holiday season, and I was out speaking about Black Friday, et cetera, the intentional customers are higher. When they come into the store, they know what they want. So, the conversion rate is higher when people come into the store. And if that's -- because they are doing more digital browsing before, so they know what they need to have might be one, but it can also be that they think about the budget a little bit more, so that when they come in, "No, this is what I want." So, the intention is higher. You'll see less of the browsing. So that's a little bit of what we see. When it comes to payments, we have the best highest-quality consumer base in the industry. There is no debate about that. So far, we haven't seen any impact of late payments or anything like that. We are, of course, monitoring it, being close to it. Every day looking if there's something changed, but as I'm sitting here today, that's what I know today that we are aware. But we have a great -- so, I can't speak for the rest of the consumer world, I can only speak for Verizon and you know we have plenty of consumers in our base. So that's what we see so far. So, we'll get to our third question, and then -- this is going to take us into the fixed wireless realm. But before we officially enter the topic, we'll come back to prepaid, so just to give our audience a little preview of what's happening. So, on the fixed wireless side, a question for the audience is, do you believe 5G fixed wireless will evolve into an effective competitor to fixed broadband services over the longer-term? And our choices are: yes; yes, but only for value in entry-level services; and no. So, while you're submitting your responses, just a question on prepaid. Hans, where are we on the TracFone integration, the synergy opportunity? And is Verizon in 2023 going to start tapping into that base in migrating prepaid to postpaid? Yes. You have seen us start doing things. And, of course, a lot of work is ongoing with the integration of TracFone and the TracFone brands. It's not only one brand, its several brands. So that is ongoing. And, of course, we're expecting synergies coming more this year when we move some of the customer that is off-grid to on-grid to our own network, which is of course, ono of the synergies, but it's also back offices and things like that. That we're also going to work with the different brands, how we're going to put them in the market, because there are a plenty of them. We have already, as you have seen, launched Total Wireless by Verizon as a new, if you say, high-end prepaid, competing there, because we didn't have anything there. Much of our prepaid was the TracFone brands going through the Walmart. So, now, we have also a higher-end prepaid. So that is going on well. When it comes to the post to prepaid migration, which actually is probably fairly big portion of what's happening in a market. Today, we have no technical support for that, because there's been different companies. Well, we're going to have that all the time, so we can actually refer in between. Of course, with total wireless is much easier, but on the some of the other brands, it's going to be taking some time, and we work with that IT evolution. The good thing right now is, as we segment these up, we basically meet all the consumer segments of the United States. And regardless of economical environment, we can play with anyone and meet the needs of any consumer in a market. So, really good. We have that inside the consumer business. We we're taking the right decisions, seeing that we're moving the money at the right time. So, feel really good about that. Great. Let's go to our results and get into fixed wireless a little bit more. So, is 5G fixed wireless going to be an effective competitor to fixed broadband over the long term? Kyle, your vote? So, 26% of the audience agree, that is yes; 66% of the audience said, yes, but only for value and entry-level services; and 8% said no. So, Kyle... Do you remember when you asked this question five years ago, you had a question, will millimeter wave work? 80% in audience said no. So, things are changing here. That's going. I like -- this is a good way to do it. I mean, I'd be interested to see, dig down a little bit deeper on why people don't think it's going to fly over the long period of time. And my assumption is it probably speeds. Because the way you framed that question was really about entry-level, right. Now, I understand a bundle and linear TV being added to it, but going forward, that kind of -- that model is broken and changing big time. I think what's going to be incumbent upon us to make that true is take that 60% of people and convince them that having a 2-gig service to your home is really, it doesn't matter, right? Now listen, we do the same thing. I have -- in Fios this year -- last year, we launched our multi-gig product for consumer on Fios. But there's very few people in our base that use full 2-gigabit of max capacity at any given time. As a matter of fact, the average user uses far, far, far less than that. It's turned into really a marketing game, frankly; on what is an attribute that we can use to market. So, I think it's going to be incumbent upon us to show people the value and the ease-of-use of a fixed wireless access offering and the benefits that can bring above just pure speed, right? So… Yes. And the trends we see in the market is, of course, that linear TV is going down and I don't think that if you asked this question, I think that the 100% is going to -- yes, it will continue down. They're going to be people who linear, but it's going down. The second is, of course, also that the convenience of the product on fixed wireless access, I mean, if you install the LTE or the C-band fixed wireless access, we're probably down to minutes or five minutes to install; it's self-install. Imagine that difference from another type of offering where you need to wait for a truck roll coming to your home, they need to dig in near your garden, they might show up two weeks later, it's very different experience. And of course, ultimately, consumers and businesses buy experiences. Experience is how the experiences service, and as long as that is working great for them, they're going to stay with it. And I think if you see in the last couple of quarters in the market, what is taking all the broadband subscribers, the satisfaction is very high on the products. So, we are pleased with it. We're going to continue to pump it, and we're going to get that demand that is out in the market on broadband, way before anybody can build something, because I usually say that it took us 22 years to pass 17 million households with fiber. 22 years, that's how hard it is. We basically have 30 million households covered with fixed wireless access in one -- less than one year. And you mentioned earlier the 2025 goal. I think it was a 4 million to 5 million fixed wireless access. So, you're still pacing towards that? And financially, maybe taking a step-back to Verizon overall, can you share just some of the puts and takes that investors should be thinking about in terms of how inflation is playing into the cost structure? How promotions stepping that up is playing into the cost structure relative to what you've been able to do with pricing and cost cutting? Yes. So, the inflation we've talked about in the June timeframe, our CFO Matt Ellis talked about it, roughly $0.5 billion impacted this -- last year of inflation, much driven by the energy cost and third-party costs and things like that, that came up. We have seen some good movements on energy prices come down a little bit, at least fuel has come down. So, there is something, but still elevated. So that will continue for us. At the same time, the promotional cost has gone up, and many of you know how that works. You basically depreciate that over three years. So, you're going to have that in your base of the service revenue. And that has gone up over the years. Even though we try to keep it down, it does come up. So that -- but from a cash flow point of view, you have already cashed it out. But from an accounting point of view, you distribute it over three years. So that's going to weigh on us a little bit of sure -- of course. Then, on same time, we did the price increase that roughly gave us $1 billion bottom-line in last year. And that is, of course, we also -- we made the calculation. We lost a couple of hundred thousand customers, consumers, and that was a clear calculation. Again, coming back to what are you measuring, service revenue and cash flow expansion. So, those are the things. We're going to continue to work on that to see if -- pricing, we going to see if there's something to be done, but I think it will not be as large as we have done before, because it was a large one we did in May last year, and we also had the churn then clinging off in October and then we had a good churn going in the rest of the quarter, so -- as we said as well. So, I think that's all sort of the boxes we have to move. And then on top of that, we launched a new cost program. We always take out billions of dollars in the company, because you need to do that in order just to stay competitive. But now we have added the program with a new structure that we launched, actually, the 1st of January. We announced it publicly, but it started 1st of January. This year, it probably going to be more of sort of investments to do the cost efficiencies, because it's a lot about onshoring, offshoring, outsourcing, insourcing. So, it might be that we need to take some costs for that this year, and then get it into the base '24, '25. But we are in a long game to see that we have economics of scale in the whole business and being able to continuously take down cost, not doing the shortcuts. We're a long-term telecom company, we're going to continue to be that. So, if we have a microphone, we might have time for questions from our audience. So, we can get a microphone roaming. Just raise your hand and we'll try to get to you. It's little crisp out here. So, if we take all of -- all this discussion together and just financially, Verizon previously had out there, I believe and correct me if I'm wrong, a goal to generate 3% plus service revenue growth and EBITDA growth in 2023. How are you feeling about that? And are there any other puts and takes that investors should be mindful of? It's a little bit early to guide for '23. We will come back to that. But ultimately, our long-term goal is always expansion on cash flow and service revenue. Then, of course, there are different years, different things are happening. But we will come back to the guidance when we meet in a couple of weeks from now. We need to see how the year comes out and all of that. So, we have a little bit of work still to be done, but our long-term goals are clear. We want to continue to do that expansion. And you know the guide that we did for 2022 landed us between $47.5 billion to $48 billion in EBITDA or something like that. That's a healthy EBITDA. We want to continue, and it's far more than double than some of our competitors in the market for us. That's important to continue to nurture, because ultimately, we want to invest in the network because a customer really care about it. We want to continue with our dividend. We are, I think, the only telecom company in the world that has kept or increased the dividend for 16 consecutive years. And we think that's what Matt and I want to continue to do. We want to give our Board an opportunity to continue to do that. That's important. That's why the $47 billion or $48 billion EBITDA is important to us. And finally, we're going to pay down debt, coming down to the levels that we talked about. Pre-C-band -- it was before pre-Vodafone. Now it's pre-C-band, and then after that, we're going to see what we're going to do. I mean, then we have the opportunity for buybacks or whatever is needed. But capital allocation is clear. It goes from the goals that I have on service revenue growth and then on expansion on cash flow, and that goes through how we want to capital allocate. And then we take action on that every day in order to do the right for the company and for our shareholders. And we got some questions from our online audience around the CapEx figure. So, to clarify, the $17 billion BAU CapEx is as of what timeframe? '24. So, '23, we still have money left from the C-band. Remember, we took $10 billion extra for the C-band deployment over a three year and the last year is next year. And some of you have been following, so you know more or less how much can be left here. I want the books to be closed, and then I will come back and say, how much will fall into '23 on that BAU. And that we will talk about when we meet later on this month. And on the subject of MEC, you mentioned earlier the opportunity to get more private 5G deals with customers. Is Verizon still on track for a goal of $2 billion of MEC in B2B wireless service revenue by 2025 from the 5G initiatives? I think we have seen a little bit slower pickup in the beginning, and partly our fault or industry fault because the ecosystem wasn't there. Kyle worked with ecosystem every day. We need certain radio-based stations for private networks, different price ranges. We need modems for certain things, et cetera. So, you need more than the handset and the macro side. That is now in there. So, we would now have offerings for cheaper private 5G network with certain suppliers and more high level, high quality. We didn't have this optionality. And that's why we now started seeing that we're actually meeting the customer demands of building private 5G network. You start with usually one use case. If that's visualization or AI or something like that with cloud, and then they find others. So, for us, this year, in '23, is more about taking those deals. Taking many of those deals and have them as a platform and then start building on them, learning from them. And no one else in the industry is even close to what we're doing. We are very early out building with some of the large hyperscalers solutions, and now we also have the ecosystem for radio. So, we are fully committed. We strongly believe in private 5G networks. And that's a revenue seem we don't have today, because we're not into WiFi networks and optimization of a manufacturing site. We're not into that today.
EarningCall_1425
Greetings and welcome to the Innovative Solutions and Support, Inc. Fourth Quarter and Fiscal Year 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. Thank you operator and good afternoon everyone. I would remind our listeners that certain matters discussed in the conference call today, including information about new products and operational and financial results for future periods are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially, either better or worse from those discussed, including other risks and uncertainties reflected in our company's 10-K, which is on file with the SEC and other public filings. Thank you, Mike and good afternoon everyone. I will begin today with remarks on our performance in fiscal 2022 followed by comments on the upcoming year and our long-term growth strategy. I will then turn the call over to Mike who will take us through the details. Fiscal 2022 marked a strong year of financial performance, revenues up 20.4% with 27.7 million compared to fiscal 2021. Higher revenue compared to the prior year was attributed [for underlying] [ph] end market support in commercial aviation, general aviation, and defense end-markets. During the year, we delivered on several programs, which included the [indiscernible] program, commercial air transport cockpit [conversion] [ph] programs, our Pilatus PC-24, Textron King Air Autothrottle, and the KC-46A. [Indiscernible] higher sales were driven by broad-based success across our portfolio products. As we have stated in the past, our winning formula starts with excellent products in attractive growing markets. This effort is supported by more than 500 cockpit upgrades in 757, 767, and 737 platforms combined with a rapidly growing presence in general aviation. Turning to our gross profit. We increased gross profit to 60.7 million in 2022, an increase of over 30%, compared to fiscal 2021. We significantly outpaced our revenue growth during the period as we gained operating leverage on higher overall sales. As a percentage of sales, gross margin increased 406 basis points, 60.1%. For the full-year, operating expenses achieved leverage with a decrease as a percent of sales 34.1% in 2022, compared to 38.5% in 2021. During the year, there were some one-time costs related to legal and professional fees, which were offset by the gain on the sale of a PC-12 aircraft. Going forward, as we continue to benefit from higher sales, we also anticipate we will be able to gain further leverage in our operating expense [indiscernible]. We believe these results reflect the success of our innovative products in the market and our dedication to excellence in delivering for our customers. I'm grateful to our team for the [diligence] [ph] as they drive results for all our stakeholders. With regards to the Autothrottle aftermarket opportunities, we have completed all certification activities with the FAA and yesterday, we received our STC for the G1000 cockpit King Air has opened up the market size of additional 700 King Air. Next, I'd like to further expand some of our short and long-term opportunities that we believe are in front of us. As we expand our product portfolio and add incremental volume into our existing platforms begin operating leverage on incremental sales. This further underscored by more than 460 basis point improvement in gross margin of revenue growth of 20% year-over-year. To increase our asset utilization, we intend to fill incremental volume both organically and inorganically. On the organic side, we have made a strategic decision to increase annual R&D spend and invest in expansion of our portfolio of products and platforms we serve. As a result fiscal 2023, we anticipate our total R&D spend to approximate 13% of sales as compared to around 10% in fiscal year 2022. Cockpit automation remains a focus area for us. As demonstrated with the development of Autothrottle for King Air, PC-12, and the Eclipse. We plan to continue strategic growth of our Autothrottle platforms. Beyond Autothrottle, we are planning to invest in additional cockpit automation. By utilizing our existing product portfolio and expanding it to other areas of flight automation, we can bring value through enhancing safety and reducing operating cost for end customers. [Indiscernible] inorganic opportunities we have assembled an internal business development team [to sue] [ph] product line type acquisitions that complement our existing portfolio. We Expect to be able to fund bolt-on acquisitions through cash on balance sheet and free cash flow from operations which exceeded $6 million in fiscal 2022. Additionally, we currently have noted and are evaluating options to utilize the strength of our balance sheet to add to total liquidity available to deploy for this initiative. Taken together, we believe we can grow our sales, increase our asset utilization, and drive incremental margin to the overall business. At full capacity, we believe our infrastructure can support a meaningful increase to our operating results and total free cash generation. To conclude, we believe that our performance in fiscal 2022 capture top line growth and demonstrated the strong operating leverage opportunity in our business. We are laser focused on growing our business portfolio to increase utilization and drive incremental margin and profit. Thank you for your time and interest. We look forward to updating you with further details in the coming quarters. Thank you, Shahram, and thank you all for joining us today. I'll review our financial results for the fourth quarter of fiscal 2022 and briefly recap our fiscal 2022 financial results. Revenues increased 5.7% to 7.3 million in the fourth quarter, compared to 6.9 million in the fourth quarter a year ago. Growth in revenue was driven by our commercial and military businesses on the product side, as well as customer service. Increase in revenue during the fourth quarter was in-part due to strong military sales related to our C-130 program. The company also saw continued improvement in commercial sales on flat panel displays for retrofit programs to commercial air transport customers. Customer service revenue rose to 1.1 million, mainly due to increases in repair work from the Department of Defense. We expect our growing portfolio of installed IS&S products to continue to generate customer service revenues going forward. New orders in the fourth quarter were approximately 6.5 million in backlog as of September 30, 2022 was 11.8 million. We include only purchase orders in-hand from the Pilatus PC-24, Textron King Air and the KC-46A long-term programs in our total backlog. We anticipate that these programs will remain in production for about a decade and should continue to add to production sales already included in the backlog. Current backlog includes a large contract with one of our general aviation OEMs that is locking in their supply chain beyond their normal advanced order. Not all of our long-term OEM production contracts include [escalation clauses] [ph] that provide for the passing along of a portion of cost increases incurred as a result of inflationary pressures. Fourth quarter gross margin expanded by almost 400 basis points to 61.5%, compared to last year. Operating leverage improved significantly as we benefited from generating higher revenue on our fixed cost platform and a favorable product mix. Our optimized operating model, relatively lower employee headcount is well-positioned to support and maintain our attractive margin profile as we continue to grow our revenue and earnings over time. Total operating expense were 2.2 million in the fourth quarter, compared to 2.1 in the prior year fourth quarter. We saw an increase in legal and professional fees, which were offset by the gain on a PC-12 aircraft. R&D expenses were around 9% of revenue as a result of lower headcount and fewer R&D projects, including those related to STC certification. We expect to target around 13% of revenue for R&D in 2023. Tax expense in the fourth quarter was 0.7 million versus 0.4 million in the prior fiscal year quarter. Fourth quarter net income was 1.6 million or $0.09 per share, compared to 1.5 million or $0.09 per share in the fourth quarter of fiscal 2021. Moving to a brief recap of our fiscal 2022 results. Fiscal 2022 was our fourth consecutive year of revenue growth with revenues up 20.4% year-over-year to 27.7 million. Net income for fiscal 2022 reached another record of 5.5 million or $0.32 per share, compared to 5.1 million, or $0.29 per share, in fiscal 2021. Not that profitability in fiscal 2022 exceeded fiscal 2021, which at that point in time was our most profitable year in more than a decade. As we highlighted during our fiscal 2021 financial results, net income was aided by a $1.1 million tax benefit from the release of deferred tax valuation allowances in the third quarter of fiscal 2021. There was no such corresponding benefit in fiscal 2022, which coupled with the tax expense of 1.8 million, drove a net income differential of 2.9 million from 2021 to 2022. On a GAAP basis, full-year net income was 5.5 million or $0.32 per diluted share, compared to 5.1 million or $0.29 per diluted share. Net income would have been 5.6 million or $0.32 per diluted share, compared to 3.1 or $0.18 per diluted share a year ago with a normalized tax rate. IS&S continues to maintain a solid financial position with significant liquidity. In addition, the company is debt free, which provides us with strong financial flexibility. We generated $6.1 million of cash from operating activities for fiscal year 2022. Net cash flow from investing activities in the fourth quarter was supported by the sale of the PC-12 airplane. We had $17.3 million of cash on hand at fiscal year-end September 30. Looking forward to fiscal 2023, we anticipate that operating cash flow and cash on hand will reflect the payment of taxes, our continued investment in engineering development, both R&D and engineering development contract programs, as well as capitalizing on potential inorganic opportunities.
EarningCall_1426
Good afternoon, ladies and gentlemen. My name is Michelle and I will be your conference operator today. At this time, I would like to welcome everyone to the Cielo Waste Solutions Q2 2023 Financial Results Conference Call. [Operator Instructions]. I would now like to hand the call over to Mr. Ryan Jackson, Chief Executive Officer, and Ms. Jasdeep Dhaliwal, Chief Financial Officer of Cielo Waste Solutions. Please go ahead. Thanks, Michelle. And good morning or in certain parts of the country good afternoon, everyone. Cielo is of course, pleased to announce its financial results for the three months -- six months ended October 31, 2022. And of course, want to make sure that we you know that all amounts in this release or in this conference call will be in Canadian dollars, unless otherwise indicated. Just wanted to also mention too that after this, Michelle mentioned there is going to be a Q&A. We have some different voices today because Jas, myself and Ryan Carruthers are all battling what everybody else seems to be battling right now with respect to sickness. So, we're getting through it as much as we can. But please excuse if we sound like Kermit the Frog more than we do ourselves today. Good morning and good afternoon, everyone. Happy to be here with my esteemed colleague, Brian and Ryan. Just to go through some of the key events or transactions we went through in Q2. So as noted in our MD&A, and in our PR, we were able to complete a payment of $1.1 million for R&D facility fabrication. Also, occupancy of our forecast facility occurred August 1, 2022 and this results in annual base rental income of $0.6 million plus 90% occupancy costs that are covered. In addition, on September 8 shares were issued for a debt for shares conversion of $2 million. This resulted in 26.9 million shares issued as debt repayment. What was also noted in Q1, just want to mention the impact of that is that there was impairment of 22.4 million which has resulted in total assets decrease of 21 million compared to April 30, as at October 31, 2022, in comparison to April 30. In addition, total liability on October 31, has decreased by 2.4 million compared to April 30 due to 1.2 million decrease in accounts payable. We've done -- put it forward our best efforts to streamline G&A and ensure we're right sizing the company for its trajectory and growth at this point. In addition to that, what you've also seen is in short term liabilities, the debt has been reclassed 4.1 million to short term liability because it's due next September so September 2023. The first loan as it is referred to and looking at the valuation of its 4.1 million. In addition, Cielo has begun preliminary conversations with Renewable U on the nine outstanding MoUs and the potential for the first location MoU in Dunmore, the joint venture. What we did there is it's been classified as short-term liability, because of our intent to settle it -- settle the nine MoUs in the next 12-month period. It's also important to note in the MD&A it was noted that we do have a waiver on behalf of Renewable U indicating that they will not be calling this 2.25 million before August 23, 2023. The important piece to note there is as noted the pieces that relate to the performance obligation of Cielo and Aldersyde, which is resulting in a conversation back and forth on the settlement of the MoUs and how best to capture our strategy and our trajectory going forward. Subsequent to that where we are operationally is wrapping up our calendar year of December. Excited for Q1. Ryan Carruthers can speak to that as the questions arise as the fabrication completion of our R&D facility and beginning our testing on various feedstock. So, to end-off October 31, we are at net loss for the three month period ended October 31 was 2.1 million, comprised primarily of G&A of 0.9 million, research and development costs of 0.4 million, finance costs of 0.58 million. Our net working capital deficit totaled 1.8 million at October 31 with cash utilized for the quarter and operations of 1.4 million and investing in 1.0 million. That's everything in mind, Ryan, the floor is yours. All right. Thanks, Jas. That is the earnings for Q2, and will now open it up, Michelle, for any questions that anybody online might have. Couple of quick questions. Regarding the feedstock, the contract that you guys are dealing with was CP or CN Rail for the ties. You're getting paid a tipping fee? Am I correct? For the ties? Okay. So you've never disclosed what the fee is that you're getting for the ties or if you have received any of the tipping fee? Wouldn't that be considered part of your revenue and should be shown somewhere? We haven't been receiving the railroad ties yet, Carmine so we're not able to recognize any revenue from that until we actually start to receive them from CP Rail. Okay. I was under the understanding that you guys did receive some in order to start testing and doing the stuff that you were doing. So, you haven't received any from them yet? Nothing, nothing from CP Rail as of yet. Our feedstock trial with CP Rail isn't scheduled to commence until April of '23. Okay, perfect. Now the other thing is these MoUs with Renewable U. So is this part of that 10 site contract that you guys had originally stated about a year ago or whatever it was with them that they would be financing the 10 sites? Yes, it's nine MoUs outstanding with Renewable U, and yes the nature of the agreement is to fund the joint venture. So, the agreement is limited liability partnership structure that has been discussed previously and disclosed publicly, a joint venture type of agreement, where they fund the capital costs the CapEx and that's the nature of it, but it's operationally it's Cielo's. Okay, perfect. I understand there was a split in terms of money or whatever up to a certain point and then once it was paid off, the amount would favor Cielo more if I was correct. When I was reading it back way back in the day, is that still standing or are you guys renegotiating that as well? We are reviewing all nine MoUs in relation to the strategy we'd like to put forward at Cielo. So at this point, it's a discussion on where those nine MoUs stand with Cielo as we're finalizing our own strategy. Okay. So, in order for those MoUs to be kicked in, I remember when it was first, when it first came out, you had to reach a certain capacity and certain flow in order for it to kick in. Was that reached for them to have these MoUs? Or is there some sort of a conflict between the two now that maybe somebody wants to get out of this out of this contract? So, what has happened is conversations have occurred between Renewable U and Cielo that those MoUs are no longer most applicable to our operations. So there was performance obligations on behalf of Cielo to hit certain leaders per hour on the Aldersyde facility, as you know, taking the previous process decommissioned it and now our R&D facility is what we call the R&D Aldersyde facility. So we have to take those new performance measures into account and have those discussions on the MoUs on what potential amendments or what that looks like to make sure it reflects current operations. Okay, so but are they trying to get out of like the operational costs or setting up these sites now or? At this point, the conversation is to amend them, no other information of trying to get out of them has occurred. Okay. So, in the absence of anyone else chiming in with respect to having a question, we want to thank everyone for continuing to be a shareholder in Cielo and also want to thank again, and I won’t make him speak if we don't have to. Ryan Carruthers. He sounds way worse than I do. And Jasdeep for joining us today. Also, of course, as we go into the busy holiday season, we want to wish everyone of course, the most blessed of the holiday season, and we expect that we'll be talking to all of you again in the New Year. Thanks, everyone. Ladies and gentlemen, this does conclude your conference call for this afternoon. We would like to thank you all for participating and ask you to please disconnect your lines.
EarningCall_1427
All right. Why don't we go ahead and get started? Good morning, happy new year and welcome to JPMorgan's 21st Annual Technology and Automotive Investor Forum here at the Consumer Electronics Show. My name is Harlan Sur. I'm the semiconductor and semiconductor capital equipment analyst for the firm. Very pleased to introduce Colette Kress, Executive Vice President and Chief Financial Officer at NVIDIA. It's been a tradition, 9 years, to have the NVIDIA team, specifically Colette, be the first to present at our investor conference because the team is driving many of the trends that you're going to hear about today, right, artificial intelligence, compute acceleration, next-generation compute platforms in automotive, in gaming and IoT. And in addition to that, the NVIDIA team is driving an emerging software and services revenue stream. So I've asked Colette to start us off with an overview of what the team announced on Tuesday at its CES special address and then we'll go ahead and kick off the Q&A. So Colette, thank you for the 9 years of support and I'll turn it over to you. Thank you. Really pleased to be here. We wouldn't miss it. Even with the great weather that we're experiencing, we wouldn't miss it and come here. I do need to make an opening reminder statement that the presentation and discussions that we will have contains forward-looking statements and investors are advised to read our reports that are filed with the SEC for information related to our risks and uncertainties facing our business. Okay. Now that I have that out of the way, I want to first start with some of the key things that we have been working on probably since we've last discussed after our Q3 earnings. Ada which is our architecture for our gaming platforms, is off to a great start. We began earlier, launching our 4090, launching our 4080 which is also becoming one of the most popular GPUs in retail. And we're here today to announce our RTX 4070 Ti version as well. So we're really pleased in terms of what we're seeing. But of course, our Ada architecture is leading and we are still working in terms of our inventory correction which is going as expected right now. Secondly, we are focused on bringing to market a large line-up of new products, particularly in our Data Center. We have our Hopper architecture working on for many years and a really important improvement for many of the new types of workloads that are hitting the market. And I think we'll talk a little bit more about that today. We are continuing to watch China and its opening. China has certainly been through quite a bit in terms of their zero-COVID policy. It's still early for us but we are watching them carefully. As you know, in the last year, in calendar '22, really, challenges in terms of both our gaming and our data center based on the economy in China and the COVID lockdowns. But we are here at CES. We're here for the consumer folks, both here for gaming as well as for auto. So let me kind of discuss some of the things that we discussed. Talked about the 4070 Ti coming to market and we are also bringing our 40 Series to notebooks. We have more than 170 different notebooks, probably able to see throughout the floor at the convention center. But it is also fueled with our DLSS which really helps bring AI and ray tracing to so many of the gamers. So our DLSS is in its third generation, very similar to our ray tracing architecture being in its third generation. We also have more than 50 new games using DLSS 3, both here and available but also coming in the next couple of quarters. So we're really excited to see what we can do with our 40 Series. But it's not just focused on on-premise gaming. Our GFN will now be available with our 4080. So GFN is our cloud opportunity for gaming and bringing a high-end 4080 is a really great experience for those cloud gamers. I love the fun fact also of what we're bringing is GFN to the automotive. We decided to bring those 2 things together. So we have several of our automotive makers that are looking to provide GFN inside of the car. So gaming everywhere and always. So we're really pleased. Moving to our automotive; probably one of the key highlights of our automotive announcements out here is Foxconn has decided to join and has adopted our Orin architecture for compute in the many NEVs, not just the NEVs that we are already a part of but any type of NEV, new energy types of cars across the world. So we're very excited about that partnership and their endorsement of the Orin architecture. There's more that we are seeing in terms of Omniverse. Omniverse has, of course, now been adopted by Mercedes in their next-generation factories, similar to some of the other automotive companies that are really seeing the need of the digital twin of the factories to find the perfect combination of how to run those factories very efficiently and using the AI. So those are some of the key highlights I wanted to start with. There's a couple other ones but a really great show and we're really pleased to be here in person. I appreciate that, Colette. Thank you for that. So I'll start off with the first few questions and I'll certainly turn it over to the audience to see if you guys have any questions. If you hit your guidance this quarter -- revenue for calendar '22 is expected to remain flattish. It's actually much better than prior down cycles and inventory correction cycles for the company. And I think it's a strong reflection of the product cycles, the diversification. As we look into this year, fiscal '24, consensus has your revenues growing. What's the team's confidence on driving growth this year in an environment where global demand trends will be soft? Help us understand the trends and product cycles that will drive the business this year. And then maybe longer term, how do we think about the overall growth profile for the different businesses, right, Gaming, Data Center, ProViz and Automotive? Yes. A great way to start out in talking about -- it's a new year. What do we want to see and focus on in the new year? One of the things that, of course, we can't control is the macro environment around the world. And the macro environment around the world is just not the same in every single country, each one of them facing quite uniqueness. But we can spend our time focusing on our opportunities in front of us as you are correct, we have a large portfolio of new products coming to market. And those even start with our Data Center business. One of our more important architectures, our Hopper architecture supporting the massive growth that we've seen in AI over the last several, several years. So not only is it about the Hopper architecture but remember, we're also bringing our Grace CPU to market. We are bringing in our networking business, our latest DPU to market with BlueField and we will also be looking at a large part of our portfolio in networking at the higher speeds that are necessary to support the environment of data center computing architecture as a whole. We're not just focused on a singular GPU type of platform. We're really focused on the data center computing as a whole. And the environment couldn't be more set up right now as folks have really understood that the ending of Moore's Law is now really here. And when you're in a situation of having to make choices, the movement to accelerated computing and the use of AI couldn't be more important for them. But that's only one part of it. As you know, in gaming, with our 40 Series, with the kick-off of the 4090, we really believe this is a great architecture, the excitement of gaming and what a third generation of ray tracing that DLSS can provide, not only to just gamers but the creators out there. There are so many different use case opportunities of that ray tracing that really takes us into the workstations on ProViz when we talk about what they could also do with it, the creatives thinking about the use of ray tracing in all of the work that they are doing. But then lastly, we are continuing a growth trajectory on our Automotive business. Orin has been a home run, both working in terms of that compute platform of many of the NEVs but we also have an $11 billion pipeline moving forward. And we're just at that turning point that we could be getting to grow to $1 billion business in our Automotive, realizing that potential of that $11 billion pipeline. But keep in mind, there is still work to do. When you'll see the work coming with our key agreements that we have with JLR, what we have with Mercedes-Benz and Daimler, all of those are still in the future. So the growth is still here to go forward. So those are the things that we're focused on, as we go forward even in the current macro environment. Near term, I think as you mentioned, the team has been working through excess channel inventories in Gaming as well as your ProViz business. On Gaming, in particular, Q2 and Q3 combined, you're shipping about 30% below end demand consumption of around $5 billion. And we went back and looked historically after 2 quarters of undershipping demand, typically -- the team typically does see an inflection in the business. You had anticipated channel inventories back to more normalized levels exiting this quarter. Is the team still tracking to this milestone? And is end consumption still trending at roughly that sort of $2.5 billion-ish run rate per quarter, plus or minus, even in this sort of tough macro environment? Yes. So the macro environment and what we're seeing in terms of demand for gaming, in North America and in Europe, as we've discussed, we're seeing solid demand. China has gone through a lot in calendar '22. The end of zero COVID may improve but it's still too early for us to say. So it has been a little bit choppy in terms of China. And we had discussed that in our Q3. However, still, Gaming as a whole is a very important area for us to focus on and the demand is definitely there and solid. Now moving to our series -- the 40 Series, bringing that to market. That's one piece of it in terms of the demand but also again, getting the correction of the channel. Yes, we are on track as we leave this Q4, our Q4 at the end of January, to be near normal channel levels in the market. We believe that this is just through a combination of the holiday season, a really, really direct focus on making sure -- working with our AIC partners and our OEMs to move that channel inventory. And you're correct that, that sometimes takes a couple of quarters to do that. And we moved quickly and we think it's working quite well. Perfect. Before I move on to some of the product segments, let me see if anybody has any questions before I move forward. So let's start off with your Data Center business. It's more than 60% of your overall revenues. The business is tracking towards 40% year-over-year growth in fiscal '23 which is more than 1.5x the cloud CapEx growth last year. And the team has driven roughly about a 70% CAGR over the past 3 years which is about 2x the annualized growth rate relative to cloud CapEx spending growth. Our hardware team is forecasting cloud CapEx spending still up high single digits this year. But more of the spending is focused on strategic compute initiatives like accelerated compute, right? And so you combine this with the next-generation Hopper ramp, your H100 ramp, continued strong enterprise adoption, strong networking demand pool, history would suggest that the team should grow the Data Center segment by double-digit percentage growth rate this year. Help us understand the puts and takes around Data Center business in this challenging macro environment this year and confidence on driving growth for fiscal '24. Yes. There's a focus within the company to really get these great products to market that we have. The Hopper architecture that we're bringing to market in feeds so many great things. The AI market has expanded exceptionally since our last architecture. And not only just the advancement of the market as a whole, just the complexity, the size of the models have continued to grow. We're seeing 3 very important areas in AI that were probably in their infancy or did not exist in the last 3 years or more. And those areas are these large language models fueled by the natural language processing. The recommender systems are yet another one that are still very, very important to monetization and marketing, a very key area. And this last one that I think you've probably all seen during the holidays is the focus on generative AI. Really a great opportunity of both now creating these models, creating these trained models and seeing what is now possible to be produced out of generative AI. We're very excited for this. But you also focused on key areas of the end of Moore's Law and what accelerated computing needs to do. We're in the right position with our architecture to both improve performance of nearly 5x or more from the last generation but also the energy efficiency because the concept of the end of Moore's Law really goes into the sustainability. What are we going to do with our data centers going forward if we're not focusing on the efficiency in there? We're all set up for all of these right things as the market continues to grow. It's not just Hopper, it is a full line-up across the board. We expect our Grace CPU to help influence the connectivity of working with our GPU, really working in terms of the speeds of all the work in terms of the data center. And so again, not being able to control the macro environment, we have a great line-up of products to help fuel growth if it's there. And the team started shipping Hopper production and initial shipments in your fiscal Q3. Server OEM availability was this quarter, right, Q4. Cloud instances available next quarter. The team noted, I think, in the last earnings call that Hopper is expected to ship in large volumes in the April quarter. Is that still the case? And can you just talk about the overall sort of cloud hyperscale customer traction, design win pipeline so far with the H100 and how that compares to the A100 cycle? Yes. Each generation now of bringing our data center architecture to market has had more advancements and more connectivity with our customers. When we think about the work that we've done to bring this to market, it's not alone. It's with our partners. It is with our customers. And so much of the work and the anticipation of Hopper may have not been an excitement of, here it is, because we've been working on it and working with our customers for quite some time. So those relationships are very important. They have been helping us both qualify it, working with it and being ready to bring this to market. We will bring production level H100 to market this quarter. We started some initial ones in Q3 but that is starting here in Q4. And yes, we expect a ramp into fiscal year '24, the first quarter as well as we continue to ramp H100. So this is a big undertaking. It is a fabulous product but the relationships in our work will really come through. As we talk with a lot of the users, the power users of accelerated compute, right, one of the things that they're anxiously awaiting is a CPU/GPU architecture which -- it's called cache coherency. But basically, the thought process is memory sharing -- like efficient memory sharing between the CPU and GPU. That's not currently available. I think Intel, AMD, I think, are 2 years away with the CXL initiative. But your Grace CPU which is expected to sample, I believe, in the first half of the year, you guys have already pre-integrated cache coherency in your Grace CPU. Give us a sense of -- like I said, your team expected to sample in the first half of the year, ramp into the market in the second half of the year. First, is the team tracking to its time lines on Grace? And how do we think about the revenue profile and the opportunity for Grace? Sure. So let's talk about why Grace and what our overall goal was there. When you think about the work that is being done for AI or the work that's been in the data center, you can't ever accomplish that with just one GPU. We have been spending years focusing on linking together multiple GPUs, essentially coming up with supercomputers, supercomputers to help both the size of the models as well as the efficiencies and speeds of the work that they are accomplishing. We've done that both with our own interconnects and then came together with Mellanox as well working on that. But now here's another important piece of why we brought Grace here. Grace gives us the opportunity to focus on the speeds between that CPU and the GPUs but also focusing, as you mentioned, in terms of the memory and how can we make sure that is the most efficient processes that we can do. Our Grace CPU is focused on very large models, large models focusing on AI, focusing on the supercomputing, focusing on high-performance computing workloads and many of our new things that we see in the future, such as digital twins and the amount of work that will take into count. So Grace and Hopper go together. Yes, we're on track for sampling in the first half and we'll bring this to market in the second half of the year. This is an area where the design wins of working with many of our customers as they see this connectivity of putting the 2 products together to be great for their opportunities and we'll continue to work on that. Let's shift the focus over to Gaming. Despite a challenging consumer market, demand for the new Ada 40 Series gaming products -- the initial ones, the 4090, 4080 seems quite good, right? We checked some of the online retail sites. 4090 is tight availability in most places. 4080 GPU card pricing is marked up about 10%, 15% relative to MSRP. So this all suggests really good demand pull-through. You mentioned at the special address -- or Jeff mentioned at the special address, 40% of your installed base has adopted RTX GPUs. And we're now in your third generation of the RTX architecture. So with the new product launch, how should we think about the additional penetration rate into your installed base? And typically, like how long are these GPU replacement cycles? Yes. So great set of questions and agree wholeheartedly in terms of our 4090, 4080 and what we're seeing out in the market. 4090 sold out quite quickly. We've already started the restocking of that, working with our AICs to do so. And the 4080 is doing very well in terms of -- in retail as well in terms of selling. We have RTX now in our installed base of nearly 40%. So interesting because we were probably on stage here several years ago, talking about what is ray tracing and are there going to be games with that. And now we have in our installed base more than 40% focused on ray tracing. Ampere architecture probably was about 1/3 of that. And so now here we come with a third generation. And there's, again, great opportunity because it's not just about that platform, it has been about our work with the ecosystem in creating the games that can now use ray tracing and use DLSS. So we're on a great trajectory there to see that take off more. As we go forward in the new year, I think you're going to see more our 40 Series come to market. Now how do we think about how much of that will be sold to those that are refreshing versus those that are coming in as new gamers? Always tough to look at but what we have seen is we bring a new generation of the product to market 2-plus years -- every 2-plus years, will bring in a new generation. But what we see is probably refreshes of the most important gamers out there to be a little bit over 3 years. So this is a great opportunity for not only upgrading to Ampere but thinking about those that are in prior generations that have not upgraded yet. That is a material performance increase and a no-brainer for them in terms of purchasing. So, I think we'll see both new gamers and that refresh. Let's switch over and talk about software. On your software solutions, you're enabling customers to come to market rapidly by developing full stack. We've always talked about the NVIDIA strategy as focused on ecosystem enablement, right? And a part of that is full stack development, turnkey solutions, managed services. You're monetizing your software platforms and you've got monetization opportunities across all of your end markets, right? The business is running -- I believe the software, services and rateable type of revenue streams, I think, is running sort of low sort of $100 million sort of annualized run rate today and you're now selling software separately, right? You've got NVIDIA AI Enterprise, Omniverse, AV. Like how do we think about the size of these opportunities? And what's the monetization time line of these software and services-based opportunities? Yes. Software is a very important piece in terms of our success almost in each one of our businesses. For many years, we have put software in both the ecosystem as well as in our products that enables customers to take out of a box and begin their work that they need because we've enabled a lot of that software. But there now is that opportunity to sell it separately. Why? It creates more of that relationship and the help that is needed for many of our enterprises. Our enterprises need that support as they are beginning their work on AI projects or otherwise. So we took this opportunity to break out software and sell it separately with our enterprises. You're going to see it in 3 major areas and probably more going forward. But the first is NVIDIA AI Enterprise. This is a core, you should think about as the operating system of AI available for our enterprises and not only being sold with us and our partners but also being sold with several of our CSPs, putting it in their marketplace. They really believe that it's not just about setting up cloud instances. They need to support that software that they are all using with NVIDIA to do that as well. So we're really pleased with that piece of work that's coming together. So NVIDIA AI is an important piece. The second one we've talked about is Omniverse. Omniverse really fuels what we will see as the future of 3D Internet and folks really working not only on those 3 dimensionals but what you may see in terms of digital twins and work in that piece. So we'll sell that, whether that be with groups inside the enterprise or even to an individual that may be a creative working on that as well. The third one is our focus on software for automotive. Our focus is not just on NEVs and creating a computing platform in the hardware infrastructure. We have a significant amount of work and effort and design wins as we focus on AV. And so we are now able to do both of selling them that hardware but also being a part of the software revenue stream that will enable within the OEMs. We'll be able to share that with them, with Daimler and both with JLR. So that is more of the medium and long term with what we're seeing in terms of NVIDIA AIE and Omniverse here right now. In automotive, as you mentioned, team has an $11 billion design win pipeline that is expected to unfold over the next few years but that business started to inflect pretty meaningfully in Q2 of last year. In fact, it's driving like 100% year-over-year growth, I think, this quarter driven by your Orin-based platforms which are starting to ramp. You also still have in front of you the revenue-sharing opportunities with Daimler, Jaguar Land Rover in front of you. How should we model -- think about the ramp into this $11 billion automotive pipeline over the next 3 to 4 years? Yes. You're going to see different stages but we've already probably passed an inflection point that we're seeing the growth of Orin with our NEVs. Why are the NEVs focused on Orin? One, both the performance level and when you're thinking about building an electric car, you're really starting from the ground up and redesigning and having that central computing platform has been very important to them. Both our work now with Foxconn as well as many of the top NEVs around the world focused on this. It is a great opportunity to continue to ramp. Additionally, the next phase, we'll be coming with our design wins both on robotaxis and bringing some of the early AV to market. In this case, this can be both in infrastructure and may have some of our software incorporated in them as well. But furthermore in the long term, probably when we get to calendar '25 is when you are going to see production vehicles for AV start to ramp and be a more meaningful position in our automotive. At this point, we're going to be now seeing that software really take off. Right now, we're still in the hardware infrastructure that's driving our revenue. But again, growing into that pipeline that we have going forward. On the financials, how do we think about the OpEx profile relative to the revenue growth, given you talked about a very aggressive cadence, right? So across your GPU, CPU and your networking products, the team is driving a 2-year cadence. That's an extremely aggressive cadence. And then on top of that, you've got ecosystem enablement, you've got software development and so on. And so how should we think about the R&D or the OpEx intensity and that relative to revenue growth going forward? When the first challenges of the economy hit, it was a focus of ours to really slow down the hiring and -- so that we can focus on our teams that we have, that we could focus on our employees that we had. And that was the very first thing that we did, is slowing down that hiring. And we are continuing to work to try and keep on a sequential basis about as flat as we can in this environment. You're right. We've got a very large portfolio of bringing new products to market and they're quite complex in that work. But our business model and our structure as a company allows quite a bit of efficiency. What I mean that is, remember, we're essentially one architecture across everything that we do. All of our software is both forward compatibility and backwards compatibility. So having that consistent unified architecture has really allowed the efficiencies and how we structure the organization as a whole. And in this environment, that is helping us fuel -- bring this stuff together. So we'll continue to focus on making the appropriate investments to bring these products to market but we're always looking for new areas to find efficiencies. Well, thank you. We look forward to monitoring the progress and the execution of the team this year. And Colette, thank you very much for your support.
EarningCall_1428
Good morning. Thank you for standing by, and welcome to the Booz Allen Hamilton's Earnings Call covering Third Quarter Fiscal Year 2023 Results. At this time, all participants are in a listen-only mode. Later, there will be an opportunity for questions. Thanks, operator. Good morning, and thank you for joining us Thanks, operator. Good morning, and thank you for joining us for Booz Allen's third quarter fiscal year 2023 earnings call. We hope you've had an opportunity to read the press release that we issued earlier this morning. We have also provided presentation slides on our website and are now on Slide 2. With me today to talk about our business and financial results are Horacio Rozanski, our President and Chief Executive Officer; and Matt Calderone, Executive Vice President and Chief Financial Officer. As shown on the disclaimer on Slide 3, please keep in mind that some of the items we will discuss this morning are forward-looking, and may relate to future events or future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our actual results to differ materially from forecasted results discussed in our filings with the SEC and on this call. All forward-looking statements are expressly qualified in their entirety by the foregoing cautionary statements and speak only as of the date made. Except as required by law, we undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise. During today's call, we will also discuss some non-GAAP financial measures and other metrics, which we believe provide useful information for investors. We include an explanation of adjustments and other reconciliations of our non-GAAP measures to the most comparable GAAP measures in our third quarter fiscal year 2023 earnings release and slides. It is now my pleasure to turn the call over to our CEO and President, Horacio Rozanski. We are now on Slide 4. Thank you, Nathan, and good morning, everyone. Thank you for joining the call. Matt and I are very pleased to share exceptional results for the third quarter of fiscal year 2023. These results show Booz Allen is gaining momentum. We are positioned well for the remainder of this fiscal year, and on track to achieve our investment thesis. This quarter, we delivered industry-leading double-digit organic revenue growth. Our strong demand momentum and continued acceleration in hiring bolster our confidence as we look ahead. Given the strength of our performance, we are making positive adjustments to our guidance ranges, which Matt will discuss in a few minutes. Additionally, and as you may have seen, Standard & Poor's upgraded our credit rating to investment grade last week. This is a reflection of our strong track record of growth and our consistent financial performance. Today, Matt and I will discuss these results in the context of our investment thesis. I will also update you on the progress we are making on VoLT, focusing on how we continue to outpace the market through the Velocity dimension of our strategy. Let's begin with our investment thesis. At our Investor Day in October of 2021, we laid out our plan to grow adjusted EBITDA to $1.2 billion to $1.3 billion by fiscal year 2025. We said, we expected to achieve that goal through the combination of industry-leading organic revenue growth; strong and stable margins, allowing for continued investment in our people, innovation and infrastructure; and capital deployment that prioritizes strategic acquisitions. The results of the last several quarters put us on track to achieve our adjusted EBITDA targets. On balance, we see more momentum on organic growth and profit than we originally anticipated. And while acquisitions remain a priority, the pace of M&A has been slower than we originally expected. We will continue to move strongly on both fronts in the coming quarters. Diving deeper into our current operational performance. Let me highlight the following areas of momentum. First, our hiring results are exceptional. We grew client staff 7.5% year-over-year and continue to quickly place new hires into billable roles. Second, and despite a relatively light book-to-bill ratio this quarter, demand remains strong. This is reflected in our trailing 12 months book-to-bill and a robust pipeline, which includes several large pending near-term awards. Additionally, with the federal budget in place, our clients have clarity on the resources available to invest in their priorities, further strengthening the demand picture. And third, we are operating faster and more efficiently by empowering our decision-makers and streamlining internal workflows. As a result, even with significant inflationary pressure, our corporate costs are growing well below our revenue growth rate, creating additional capacity for investment. These operational metrics give me confidence of continued momentum in the business. One additional note on the financials we are reporting today. In our 10-Q, we disclosed we have entered into settlement discussions with the Department of Justice related to their investigation into certain elements of our cost accounting and indirect cost charging practices. We are exploring whether a negotiated resolution to the matter is possible with the DOJ. In connection with those discussions, we recorded a reserve for $124 million in the third quarter of fiscal year 2023. At this time, we do not know if or when a settlement might be achieved, and if achieved, with the total dollar amount might be. Before turning the call over to Matt, let me take a few moments to update you on VoLT. Over a decade ago, Booz Allen correctly anticipated that technology would become the dominant force in the success of the federal government's core missions. We prepared for that evolution and established a unique position in the market. Today, as the change we saw coming is upon us, we have first-mover advantage and are a recognized leader in driving technology adoption in the government. In this moment, when technology has become a catalyst for mission success, speed is key. Technology, missions and the competitive environment are all changing more rapidly in this next evolution of the market. In response, the V for Velocity in VoLT, represents our imperative to get faster and stay ahead of the pace of change. So in addition to faster decision-making and streamlined internal processes, Velocity includes two market focused dimensions. The first is leveraging technology to accelerate organic growth, and the second is using M&A as a strategic accelerator. Our aerospace business helps illustrate the first point on accelerating organic growth. As an example, earlier this fiscal year, we reported winning the CyPrESS contract, which is transforming how cyber is delivered across the entire NASA enterprise. Our investments and experience innovating in the most complex cyber missions uniquely positions us to win this work. We have quickly hired and ramped up on this contract, and are now one of the main providers of cybersecurity at NASA fully engaged in protecting the space agency's assets and infrastructure. In other parts of aerospace, we're also leveraging technology to evolve the mission. We are accelerating digital transformation across the Air Force's weapons, enterprise and test ranges. And in today, rapidly evolving threat environment, we are helping our clients re-imagine the future of secure communications on military aircraft platforms. From exciting new wins, to expanding on decades-long work, we are inserting new technology across Air Force, Space Force and NASA missions. And as a result, our aerospace business has accelerated from flat to double-digit organic growth over the past two years. Let's turn now to the second dimension of Velocity, using M&A as a strategic accelerator. EverWatch is our most recent example of this. We are pleased to have completed the acquisition in October, and integration is underway. Through EverWatch, we gained access to classified software development capabilities to support national security missions faster than we could have built and scaled them on our own. At a time when mission success or failure is dependent on the right technology, acquisitions like EverWatch help us bring innovation to missions at speed. We continue to build our M&A pipeline with a focus on acquisitions that have potential to accelerate our organic growth. One final point to close. In December, I participated in the Reagan National Defense Forum, with some of our most senior clients, industry colleagues and legislators. Our discussions centered largely on how technology is fundamentally redefining the battlefield and what we need to do as a nation to be better prepared to stay ahead of facing threats, especially China. These conversations, like many I have with our clients across defense, intelligence and civil agencies, reinforced for me, the technology has gone from an enabler of mission to a catalyst of mission success. Thus, I believe the investments Booz Allen has made over the past decade, combined with our continued progress on VoLT, and of course, our incredible people, uniquely position us to accelerate into the next decade, outpace our competitors and make the greatest difference through the work we do for all our clients. Thank you, Horacio, and good morning, everyone. As Horacio noted, we are extremely pleased with our financial results, both for the third quarter and for our fiscal year-to-date. We remain the industry's organic growth leader and continue to operate the business very well. We have built excellent momentum toward reaching our fiscal year and investment thesis objectives, and we expect this momentum to continue given our strategic positioning, our strong execution and a positive budget environment through the end of the government fiscal year. Before discussing our third quarter results in detail, I will highlight a few key areas of our fiscal year-to-date performance. Over the first three quarters, we delivered 9.5% organic revenue growth. This is a result of us winning work aligned with our VoLT strategy and hiring, retaining and efficiently deploying the right talent. Our adjusted EBITDA margins of 11.5% in this period reflect continued strong contract level execution and prudent cost management. We deployed $714 million of capital through three quarters, a combination of dividends, share repurchases and the strategic acquisition of EverWatch. As a result, Booz Allen remains on track to achieve our investment thesis goals and to continue delivering excellent value to our shareholders. Now please turn to Slide 6, as I discuss our third quarter results in detail. At the top line, total revenue in the third quarter grew 12.1% year-over-year to $2.3 billion. Revenue excluding billable expenses grew 11.2% to $1.6 billion. Almost all of this growth was organic, as our organic growth accelerated to 11.6% for the quarter. I am particularly pleased that our revenue growth was driven by double-digit contributions from each of our three federal markets. In Defense, revenue grew approximately 10% year-over-year led by strong performance in our Aerospace and Joint Combatant Command accounts. In Civil, revenue grew by approximately 16% year-over-year, highlighted by growth in our health account, and in the mission-critical cyber and digital solutions work we perform across the civil market. In our Intelligence business, we grew by approximately 14% year-over-year, driven by our National Cyber and Defense Intelligence accounts, as well as our strong hiring across the board. At this point, we expect a stand-alone fiscal year 2024 contribution from EverWatch of between $180 million and $200 million. Our Global Commercial business, which accounted for roughly 3% of our revenue in the quarter, declined approximately 13% year-over-year. This reflects the sale of our MENA and Managed Threat Services businesses in the second and third quarters, respectively, that streamlined our commercial business and positioned it well for future growth. On the labor supply side, our client staff headcount grew to 28,269 at the end of the third quarter, an increase of 1,975 employee’s year-over-year, or 7.5%. Total headcount, inclusive of corporate staff increased to 31,130, this equates to growth of 1,677 employees year-over-year, or 5.7%. These figures included over 400 employees who joined at Booz Allen from EverWatch in the third quarter, as well as the approximately 80 employees who left the firm with our MTS divestiture. The transformation of our talent acquisition life cycle and improved levels of attrition in the quarter drove this continued acceleration in headcount. These results show that we continue to attract and retain the high end talent we need, even in an extremely competitive labor market. On the demand side, net bookings for the third quarter were approximately $197 million, which translates to a quarterly book-to-bill of 0.09 times. Our trailing 12 months book-to-bill metric remained solid at over 1.2 times. This is the best indicator of sustained demand as it normalizes for quarter-to-quarter volatility. We can attribute our relatively light book-to-bill number this quarter to two factors. First, seasonality, as this is consistent with our historical bookings pattern. And second, the timing of a few large awards and protest resolutions that were pushed into the fourth quarter. This timing dynamic includes a large contract award in our intelligence market that Horacio referenced in our last earnings call. This award, which has meaningful overlap with work we are performing today is currently under re-evaluation. In the quarter, total backlog grew to $30 billion, which is approximately 8.2% year-over-year. Funded backlog grew 12.4% to $4.5 billion. Unfunded backlog grew 7.6% to $10.1 billion and priced options grew 7.5% to $15.4 billion. We are very comfortable that this backlog and the strength of our proposal and award pipeline support our near and medium term growth aspirations. Consistent with our strong top line performance, we generated $244 million in adjusted EBITDA in the third quarter, up 9.8% year-over-year. We ended the quarter with an adjusted EBITDA margin of 10.7%, down 20 basis points year-over-year, and in line with our expectations. Our adjusted EBITDA margin reflects a mix of drivers with strong contract level performance and solid cost management, offset by a higher billable expense mix, higher unallowable spend, and the impact of wage inflation on our fixed price and time and materials contracts. Our net income decreased 76.2% year-over-year to $31 million. This was primarily a result of the $124 million legal reserve, we recorded this quarter in connection with the DOJ matter. Adjusted net income, which excludes this legal reserve was approximately $142 million, up 4% year-over-year. These were driven by our strong operating results, which were partially offset by higher tax and interest expense compared to the prior year. Diluted earnings per share decreased 75.8% compared to the prior year period to $0.23, primarily as a result of the aforementioned legal reserve. Adjusted diluted earnings per share, which excludes the legal reserve, increased 4.9% year-over-year to $1.07. Turning now to the balance sheet. We closed the third quarter with a cash balance of $371 million, and a $1 billion untapped revolver. Free cash flow for the quarter was $117 million, the result of $139 million in cash from operating activities, net of $22 million of capital expenditures. Operating cash was supported by collections that kept pace with our revenue growth, but with seasonally light due to acquisition and divestiture-related expenses paid out in the quarter. Now turning to Slide 8. During the third quarter, we deployed $510 million of capital. This included approximately $440 million connected with the EverWatch acquisition, $11 million in share repurchases at an average price of $96.30 per share, and $57 million in quarterly cash dividends. Our net debt at the end of the third quarter was approximately $2.5 billion, and our net leverage ratio was approximately 2.5 times. As Horacio mentioned, we were delighted by last week's news from Standard & Poor's, who upgraded us to BBB minus and investment-grade credit rating. We look forward to the enhanced flexibility and access to capital markets that this upgrade will provide, and we will continue to be good stewards of our balance sheet, while deploying capital in a patient and disciplined manner. To this end, I am pleased to announce that our Board has approved a $0.04 increase to our quarterly dividend. This dividend of $0.47 per share will be payable on March 1st to stockholders of record as of February 10. Finally, let me summarize our updated guidance for full fiscal year 2023. Please turn now to Slide 9. Our excellent performance and sustained momentum through the first three quarters give us confidence in our ability to finish this fiscal year strong. At the top line, we are increasing our guidance for full fiscal year revenue growth to between 9.5% and 10.5%. As a reminder, our fourth quarter has one fewer working day when compared to the prior fiscal year, which impacts year-over-year quarterly growth comparisons. We still expect margins to be in the range of high 10% to low 11%. We now expect adjusted EBITDA to be between $995 million and $1.15 billion in sync with the increase in our top line guidance. We are also increasing our ADEPS guidance to a range of between $4.35 and $4.50 per share. We now expect capital expenditures to be between $80 million to $90 million for the fiscal year. And lastly, our fiscal year 2023 operating cash flow guidance remains unchanged from last quarter. In closing, like Horacio, I really want to thank our dedicated employees, whose relentless focus on the mission is really the root of our outstanding performance. Because of them, Booz Allen remains on track to achieve our investment thesis goals and to continue to deliver excellent shareholder value. Thank you for the time. So, Horacio, in your opening remarks, you mentioned M&A as a strategic accelerator, and you typically haven't done deals, but you're focused on them now. Can you maybe give us an update on Liberty and Tracepoint, as well as EverWatch, given you just closed the books on that one? And it seems like the revenue contribution is coming in a lot better there? Yes, absolutely. So let me start by saying, we're very happy with the results of the quarter and particularly happy with the organic performance of the business, which is really ahead of our expectations at this point on the trajectory of our investment thesis. And as I mentioned on the opening remarks, we are a little bit behind where we thought we would be at this point on the M&A side, largely environmental factors. But overall, we're very pleased with what we are on the journey, and we're on track. And that's really the key message. One click down from that. As I mentioned, now work backwards, EverWatch is finally closed in October, we're integrating it. There was a little degradation of talent levels, while we were waiting for it to close. And so we're accelerating their hiring because they have pretty robust demand there that we want to meet, and that's where that is. Tracepoint is getting fully integrated into our commercial business. As you know, that is a small acquisition and a small business, but it's an important capability as we do incident response more aggressively across the commercial market. And then Liberty, which is now fully integrated into our business, has been an extraordinary success and continues to be - they are - it's a big part of our health team. They brought low code, no code capability that is both really valuable across the health account, but really increasingly across the federal government, and we're really pleased with that. So overall, we're looking to do more things that look like Liberty. They're hard to find. And we're - as Matt always says, we're going to be patient and disciplined on this, and that's where we're going. Thank you for that. Maybe if I could follow-up just on the civil business as a whole, which clearly includes Liberty. You mentioned, I mean, the business is growing at a spectacular mid-teens rate. So what's sort of driving that? You mentioned health and cyber mission work. Is it a few contracts? Or is it just you're going into new addressable markets there? It's broad-based. I think that's a great question. I think this speaks to really VoLT and Velocity and everything else that we are doing across the business. This notion of inserting new technology into existing missions really resonates with our clients. It's what they need to do to meet the demands of the moment. I honestly believe it is what's driving this double-digit growth that we experienced this quarter and really the broad-based growth across many parts our portfolio. In civil, in particular, it's not just health. There is significant elements of our treasury business that are growing very well. And we're happy with what we're seeing. I mean, the civil agencies are focused on digital transformation. They need to be, and we like to believe that we are a catalyst and a partner with them on this journey, and that's what underlies our growth opportunity. Hey, Horacio, you noted before and you've noted over time the Booz is supply not demand constrained. Now you just grew client staff down kind of almost 4% quarter-over-quarter, which is clearly benefiting sales. Do you have any concern that pendulum starts to swing the other way and utilization becomes a factor, maybe not this quarter, but as we go further into the calendar year? That's a great question. And here, I want to give credit to really our team and operating teams, the work that Kristine Martin Anderson and our people team are doing. They really have re-wire the way we hire to - against the velocity dimension, so that we actually can hire faster. And then - and this is really mentioned, we really haven't spent as much time before so that we can put people that are hired into billable opportunities faster. And I think we're seeing some benefit of that. The other benefit is demand, as I mentioned, is very strong across the board. And so I'm not sure even if we wanted to, that we could keep people on the bench very long. So you put all of that together and at least for the moment because who can predict the long-term future, there's a lot of momentum in the business. And we are doing this - we're seeing this dynamic where we're hiring at almost record levels or at record levels, and we're placing people on contract fast enough that our billability or utilization is remaining very, very high. So again, when we talk about confidence and momentum in the business, that's - I think that's what's underneath a lot of our words. So maybe just for my follow-up. You also mentioned during your prepared remarks, greater clarity for your customers post budget in late December. Have you noted any acceleration in spending following the passage of the budget? And if you haven't, when would you expect that to start materializing? I could that provide some acceleration from the already high growth you're seeing. I - we have not seen a significant change. I think what we have seen is a steadiness and confidence that the emissions that they're focused on are going to be supported at least through the balance of the current fiscal year. And so I think that's been positive. As we've noted and others have, the award environment isn't the fastest we've ever seen in terms of things moving to the ride and protests and all of that. That seems to continue. But against an overall very strong demand backdrop, as you can tell by our numbers, we're obviously not demand constrained. We're doing really well on hiring. And when you put it all together, again, it's a story of both momentum that we've seen over the last few quarters, and we expect - or we hope to continue. Horacio, near the end of last quarter, you secured a $2.2 billion contract called Morphick. That seems pretty strategic in addition to being one of your largest ever awards. Was this contract a big driver of your strong organic growth in the December quarter? And can you provide more detail about what the contract pertains? So we were a little limited in terms of what we can say about that particular contract. It's - I guess, what I will say is it's still - it's over piece of all of the work that we keep talking about where we're bringing leading-edge technology into existing mission sets, programs of that size ramp slowly. I think the message I would likely to take away is the growth that we're seeing is broad-based. That's obviously a defense contract. And as you can see, both civil and security also posted very strong growth. So we're seeing strong demand across really, I can't say it's every single part of our business, but lots of aspects of our business. And the team is doing a great job of hiring against our demand, bringing in the right people, with the right clearances and the right technical expertise, so that we can ramp up and continue the momentum. Great. And for Matt, I think you mentioned the possibility of accelerating M&A in the future quarters. Should we expect acquisitions to be small sub $1 billion type so that they are easily digestible? Or do you have any aspirations for a much larger transformative acquisition? Thanks, Louie. Never say never. But I think right now, we're more focused on small to mid sized tuck-ins that are strategic accelerants. We're really pleased with our capital deployment to date, deployed $510 million in the quarter, including EverWatch. And as Horacio said, they've got some short-term hurdles they need to overcome on the supply side. But from a demand perspective and in terms of long-term strategic value, we really see it as an opportunity for us to transform portions of our intelligence business. So we're working it. We've got a pipeline. As you know, the M&A market has been and relatively slow in the past couple of quarters for a handful of macroeconomic reasons. But we're going to play the game that's in front of us. And the strength of our balance sheet just gives us a lot of flexibility to do that. Thanks so much. Yes. Good morning, guys. So you mentioned protest is a reason for the soft bookings. Could you walk through the large Intel contract, is that one that you were awarded and now is being - is under protest and maybe give us some color on some of the others, too, if you could? I think, generally speaking, this is what I can tell you. I think the contract that you're describing, I mentioned briefly last call and Matt talked about it in the prepared remarks, it relates to our cyber work in the Intel market and has overlap with some of our existing contract. The award was pulled back and it's been re-evaluated. So it's not technically under protest. And so we - as you know, because you've followed us for a very long time, we generally don't comment on specific procurements, while they're under evaluation. Here's what I can tell you about the processing well, about this dynamic in particular and then the broader environment. The - as you know, we're not demand constrained. We have $30 billion in backlog. And even with our record hiring, we're still having filled every rec. And the place where it's hardest for us to recruit is in clear technical staff for work in the intelligence community. And so we still have a lot of open recs there and now a significant volume of open recs had EverWatch. So our goal ultimately in this area is to retain and grow that workforce and deploy it against the work that is in front of us, I think we're doing well there. There's more work to do because, ultimately, we want to continue to grow that workforce as the way which we grow the Intel business overall. And then the last point I would make on the protest environment overall, that continues to be a slow process. We have a number of things that have slid to the right as a result of that. I think that we are very optimistic about the awards picture in the near term, as we mentioned in the prepared remarks. And we're feeling good about the overall demand picture and the momentum that we have. One broad follow-up. It seems like there's plenty of money around to make awards, but sort of across the industry, it seems like the activity is a bit slower. Some of your peers have talked about the lack of contracting officers. And as you know, the process to become a contracting officer is pretty onerous. Do you see that as a problem that there's just not enough qualified people to kind of make the awards, and that's 1 of the reasons things are slowing? Yes, to the extent that the contracting workforce in the government has been constrained for a long time, and they've been under pressure for a long time. Again, you and I have been on these calls for a while, I mean there was a time where, for example, the department wanted to re-compete things more often. And so that increased the workforce or the workload on the contracting shops significantly without a corresponding increase on the headcount that needed to address that from the government side. And that's been a perennial issue. I don't know that it is any worse now than it's been in the past. Again, ultimately, from our perspective, the - I'm sorry, I'm saying it again, but the demand picture right now feels very strong. Good morning. This is Eric Allen for Matt. Just a quick follow-up on book-to-bill. I know it's more of a timing thing, but was there anything taken out of the backlog, any cancellations there? No, nothing meaningful. I think the top line message is we have the backlog and the award and proposal pipeline we need to meet our near and medium-term growth aspirations. And even more important, the capabilities and solutions we're building in line with our VoLT strategy are really resonating with our clients. So we said it both in stronger quarters like Q2 and lighter quarters like this one that we want to focus - we focus on last 12 months book-to-bill. And if you look back at where we were at the end of Q3, the prior fiscal – three fiscal years, that was between, let's say, 1.15 and 1.3 and right now, we're at 1.22. So we're right in line with where we want to be and Q4 is shaping up well. Okay. Thanks. If I could do one more. I think we're seeing more military aid packages being sent to Ukraine lately. So just wondering, if you're seeing any benefit from all the support money? I had the pleasure of spending time with our team in Europe late last year and just be inspired and amazed by the work that they're doing in support of our government as our government supports Ukraine. And so we're well deployed in the middle of that mission, helping drive intelligence, helping drive analysis and doing really good work. So overall, that - sort of that's our posture. It's a posture that is longstanding. It's a longstanding team that has pivoted to this mission. There's obviously been some growth on the team as a result of additional mission needs. I would expect that to continue. But I don't see that as a meaningful driver of growth as much as I see it as a real demonstration of the great work that we got on people can do as we bring technology to the mission needs. Thanks. I wanted to ask a question about the debt ceiling negotiation. As these proceeds, but do you have see any risk to the spending patterns in the current fiscal year as procurement officers' kind of watch this being bantered about in the news? And are there any analog experiences in history that you would reference as sort of being benchmarks or examples of how impacts either emerge or don't? It's really hard to predict that what will happen sort of second and third order effects of the debt ceiling debate. It's even hard to understand what the first order effects will be. I will say this. I mean, obviously, a protracted fight on that in our view is not good for the country, and it's certainly not good for our clients and by extension is not great for us. I think part of our approach to all of this is - and this is why - is to build momentum to drive the business that's in front of us, to grow organically, to have the right people doing the right work at the center of these missions, which tends to be more resilient to overall sort of external uncertainty. That's what we have done in the past. That's what we are doing now. And that's what gives us confidence that despite the fact that there's that issue, there's next year's government budget and all of that, which are things that we are watching very closely. Ultimately, we are on track and remain on track to deliver our investment thesis to advance VoLT and to be the kind of partner to our clients that they need us to be right now. And the industry has a lot of experience, unfortunately, with budgetary uncertainty. We have it. Others in the industry have it. And as Horacio said, we've told the team is play the game in front of us. And the best thing we can do is to prepare for uncertainty is to build as strong a business as possible. And we feel like we're well positioned strategically through Volt, as Horacio mentioned, and our client positioning operationally. We're running the business very, very well. I think more disciplined than we've ever run it. And financially, given the strength of our performance and the quality of our balance sheet. And we sort of glossed over it because there's a lot of news in the quarter, but I think us being upgraded to investment grade is a reflection of that. Absolutely. As you look at your principal government customer sets in civil, defense and Intel, how would you stratify the growth prospects for calendar '23? And does it sort of purely map against headline budget outlays and growth this year? Or is there a nuance or difference among them? You know, from my perspective - well, first of all, as you see, we have strong growth across the board right now. And the type of work that we are doing under VoLT, the work we're positioned to do, again, around bringing AI, cyber, digital transformation into existing missions, into expanded mission scopes around space, around INDOPACOM in China around some of the key issues, which at some level are some of the few bipartisans remaining give us confidence that we are doing the right work and in the right place. And at least for the immediate future, the increases in head count and the speed at which our headcount is - our people are getting on programs give us confidence that the business has strength. And that's our approach, and it's not limited to one small piece or another. It's where - we believe that's a broad-based view. And one moment. Our next question will come from Mariana Perez Mora from Bank of America. Your line is open, Mariana. So my question is about free cash flow in order for - to get to hit your cash from operations outlook, you have to generate more than $200 million net of a fair amount of tax payments. Could you please give us some color on how to bridge to that $200 million-plus free cash flow generation? Happy to. Our cash performance year-to-date has been solid. Again, that's why we reiterated guidance. Thankfully, we took a conservative approach and didn't assume 174 would be repealed. So we anticipate, and you see that in the bridge we provide an - we provided in the presentation initially 174 being about 170 - about $140 million this year, and we have $175 million of other cash taxes. So to get to the bridge that you described, we're obviously growing, and collections are keeping pace with growth in Q3. Outlays were also up, including a couple of things that were temporal. So we feel like we've got the ability to generate cash and invest in the business and hit our targets in the guidance. Thank you. And then a follow-up to Tobey's question on consumer resolution or like this potential year-long continue resolution next year. I understand that the right strategy is prepared to the future and not for the headwinds of the process to get to that future. But can you help us understand, how much of a headwind could be a year-long Continuous [ph] solution into your organic growth? At this point, I think it's a little premature to try and speculate what the budget picture will look like next year and how it might play out. I think as just Matt pointed out, we and the industry have become very adept at managing through this budget turbulence. We - and I think that's ultimately what we are focused on, I think when we get closer, if we know more and there's more clarity, we'll be happy to engage at that time. The one thing I can tell you is our business right now is doing well, their strength on the demand side, their strength in the supply side, their strength on the balance sheet. And all of that strength put together give us confidence that within reason, we can - we're preparing well to weather a storm and deliver on our investment thesis commitments through FY '25. And I'm showing no further questions at this time. I would now like to turn the conference back to Horacio Rozanski for closing remarks. Thank you, and thank you all for joining us this morning. As we come to a close on this call, let me first recognize that we have a new member of our Board of Directors. As we announced last week, Rory Read has joined the Booz Allen Board. Rory is Senior Vice President at Ericsson and the President and CEO of Vonage, which is Ericsson's global telecommunication platform. I'm really excited to have Rory on our Board and I'm already seeing how we benefit from his expertise, both as a technologist and as a business leader. And then lastly, I want to take a moment to acknowledge and recognize and thank the amazing people of Booz Allen. For sure, for their hard work and dedication because it's their hard work and dedication that delivers the exceptional results, we were able to discuss with you today. And also for their generosity and what they do for the communities in which they live and work. And specifically, through our year-end giving campaign, our employees contributed more than $1 million think about that word, more than $1 million to the causes that they are most passionate about. And because of the firm's match, we ultimately gave over $2 million to more than 2,000 non-profit organizations, and this is the highest impact we have ever made through year-end campaign. Our people's commitment and service to our communities, to our clients, to each other, they're the core of who we are. They are the core of our purpose and our values. So I come to work every day, it is really my colleagues that inspire me. So I just want to say, once again, thank you. Thank you, Booz Allen.
EarningCall_1429
Good day, and thank you for standing by. Welcome to the Extreme Networks Second Quarter Fiscal Year '23 Financial Results. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Stan Kovler, Vice President, Corporate Strategy and Investor Relations. Please go ahead. Thank you, and welcome to the Extreme Networks fiscal second quarter 2023 earnings conference call. I'm Stan Kovler, Vice President of Corporate Strategy and Investor Relations. With me today are Extreme Networks' President and CEO, Ed Meyercord; and Interim CFO, Cristina Tate. We just distributed a press release and filed an 8-K detailing Extreme's financial results for the quarter and also an 8-K detailing our CFO transition. For your convenience, a copy of the press release, which includes our GAAP to non-GAAP reconciliations, our earnings presentation are both available in the Investor Relations section of our website at extremenetworks.com. And I would like to remind you that during today's call, our discussion may include forward-looking statements about Extreme's future business, financial and operational results, growth expectations and strategies. All financial disclosures on this call will be made on a non-GAAP basis, unless stated otherwise. We caution you not to put undue reliance on these forward-looking statements, as they involve risks and uncertainties that can cause actual results to differ materially from those anticipated by these statements, as described in our risk factors in our 10-K report for the period ended June 30, 2022, is filed with the SEC. Any forward-looking statements made on this call reflect our analysis as of today and we have no plans or duty to update them except as required by law. Thank you, Stan, and thank you all for joining us this morning. We had another record quarter, as demand for cloud-driven networking and for Extreme Solutions remains exceptionally strong with good visibility through fiscal year end '23, leading us to raise our full year revenue outlook to the high end of our range. Our share gains are evident by a second consecutive quarter of double-digit revenue growth, 17% growth in product revenue, record free cash flow and a sizable backlog. The resiliency of our business combined with a strong execution of our teams and focus on shareholder value continues to position Extreme well for the long-term. The sequential increase in revenue and margins led to continued improvement and our operating model to record levels just shy of 15% operating margin, and we achieved EPS of $0.27 in Q2, up from $0.21 in the year ago quarter. We expect these bottom line earnings trends to continue. Both our fabric and cloud solutions are driving significant differentiation for Extreme, particularly due to our ability to deliver network automation, hyper-segmentation, unmatched security. Today, our fabric solutions offer a simple way for customers to tie all the components of their network together, and the branch, campus, data center to the cloud. It removes network complexity, speeds deployments and streamlines operations. The transition to universal products has proven successful, with well over 60% of our bookings now on universal platforms for Wired and Wireless Products. We're on track to achieve this transition by year end calendar '23 with over 90% coverage of our portfolio with the universal platform. This calendar quarter, we'll be announcing a set of unique innovations, involving ExtremeCloud SD-WAN and our widely deployed Extreme Fabric. These capabilities will enable our customers to improve visibility, management, application performance and security at the edge of the network. This further extends our vision of one network, one cloud, one Extreme over the wide area network with a truly differentiated fabric technology. We're focused on helping our customers find new ways to deliver better outcomes across their organizations. During the quarter, 44 customers spent more than $1 million with Extreme, up from 37 last quarter, is another signal of how Extreme continues to take share and move up market. The top wins for the quarter included a multinational bank in Hong Kong, where we beat two of our largest competitors to modernize the infrastructure for surveillance, digital cornerstone for safety and security. After using a competitor for many years, Extreme was able to bid on this project and win. A large school district just outside of Houston was looking to streamline management of its network, which sprawls across 92 buildings and support 60,000 students. Our fabric technology will provide full visibility across the network, simplifying and unifying network management, improving security at every site, and automating network configuration and provisioning to significantly reduce time spent on new deployments. A leading NHS Trust Hospital and Cancer Research Center in London upgraded their networks to continue to offer patients the most modern care. New bandwidth heavy applications, telehealth visits and medical devices are crucial for patient monitoring and require a Wi-Fi 6E fast, reliable, low latency network that could be easily managed by Extreme Cloud IQ. Our competitive position has never been stronger. Given our relative size, even small share gains have a large impact on Extreme's topline. We remain the fastest-growing company in our space. Third-party analysts, industry press and partner community have taken notice and we received numerous accolades and awards for our solutions and service. For the fifth consecutive year, we were named a leader in the Gartner Magic Quadrant for Wired and Wireless Local Area Network Infrastructure. Our innovation, vision and continued execution with solutions like fabric and digital twin were significant factors in our ranking. Our new customer logo wins contributed a higher percentage of our bookings. About half of our new logo wins are coming, because of fatigue and lack of innovation from some of the largest players in the industry. We're taking advantage of these market dislocations and when customers realize, they'll benefit from interoperability between platforms, simpler licensing structures, productivity from Extreme versus our largest competitor, we're quick to capitalize on these opportunities to win new business. More customers and partners choose Extreme, because of our ability to offer unlimited end-to-end network that can be managed within a single-cloud platform. Customers also love our universal hardware that offers choice of both cloud-based and on-premise deployments. As product lead times continue to improve, we expect our share gains to accelerate. Last quarter, we strengthened our go-to-market organization by appointing Pete Brant as Senior Vice President of U.S. Sales. Pete is a proven sales leader focused on taking share and building SaaS organizations coming from leading networking and security companies, such as F5 and Fortinet. We ended Q2 with ARR growth of 29% year-over-year, while SaaS deferred revenue grew at 38% year-over-year. Our innovative cloud solutions are pulling through product sales and we believe the level of organic subscription growth we're seeing is sustainable. In addition, the improvement in supply chain, our ability to deliver products, most notably Wireless LAN this quarter supported a strong pull-through of software subscription for the next several years. On the supply chain side, our ability to pull in components enabled us to achieve revenue upside, which we believe is sustainable into the second half of the year. As a result, we are raising our revenue outlook to the high-end of our prior 10% to 15% guidance range. We continue to be laser-focused on tactical execution to meet our customer’s needs. This quarter alone, we qualified an additional 37 component suppliers and significantly reduced our parts shortages. Based on all the actions we've taken with our supply chain over the past year, we now have visibility and confidence that the ramp of our product deliveries will continue to improve and reduce lead times. With a strong outlook for bookings growth and the gradual improvement of supply, we expect backlogs to remain relatively stable for the next several quarters. We're in the beginning stages of an accelerated wave of product shipments and revenue growth over multiple quarters. The majority of our backlog consists of the latest generation universal products that pull-through subscription and service bookings. So when our backlog shifts, it will also unleash subscription and maintenance services revenues over the next several years. Throughout calendar '23, we have several universal product innovations coming to market that will drive better outcomes for our customers. In addition to the 5720 switches designed for higher data throughput, such as our Wi-Fi 6E access points will be coming to market with new industrial switches for hardened environments and smart city deployments. New distribution switches to support the higher power over Ethernet and density requirements of Wi-Fi 6E and Wi-Fi 7 in the future. Several new datacenter and core products will also launched throughout the year. Lastly, I want to welcome our Interim CFO, Cristina Tate to the call. Cristina is a proven and highly respected leader at Extreme, and I expect a smooth transition as we enter this new growth phase. Remi accepted a new opportunity with a privately owned software company and will stay on with us through the middle of next month to oversee the transition. He was a great partner and leader, and has set the company up for success. Thanks, Ed. Q2 results highlight solid execution by the team, as well as an improvement in the supply chain environment. Our ability to deliver product resulted in record revenue and continued the trend of double-digit revenue growth we have achieved in seven of the last eight quarters. Our SaaS ARR continued to rise. We improved our margins sequentially, and we generated record cash flow, which enabled us to repurchase 2.6 million shares of our common stock. Our second quarter revenue of $318.3 million grew 13% year-over-year and 7% quarter-over-quarter, which was above the high end of our expectations entering the quarter. With a product book-to-bill ratio of 0.9 times for the quarter, our backlog stands at $542 million, equivalent to 2.5 quarters of product revenue. The slight decrease in backlog primarily reflects accelerated product shipments. Product revenue grew a healthy 17% year-over-year and 8% sequentially, attributable to both campus switching and Wireless LAN, partially offset by a decline in data center. The ongoing loosening of the supply of access points resulted in Wireless LAN revenue accounting for 34% of product revenue, up from 30% in Q1. Subscription bookings grew by 30% year-over-year, in line with the long-term guidance of 25% to 35% growth provided at Investor Day last May. SaaS ARR grew 29% to $115 million, up from $89 million in the year ago quarter. Subscription deferred revenue was up 38% year-over-year and 9% quarter-over-quarter to $187 million. Q2 earnings per share was $0.27 above the high end of our guidance entering the quarter. Revenue on a geographic basis once again reflects the timing of product shipments to our distributors across the regions. Regarding our bookings performance, recall that we experienced very strong demand in Q1, resulting from pull-ins of deals from Q2, ahead of the list price increases as of October 1. Then during Q2, we saw less of a year-end budget flush than we normally see and it's a tight supply environment. This resulted in a slight decrease in bookings in Q2. However, for the first half as a whole, bookings grew low-single digits year-over-year. As a reminder, last year in the first half, our bookings grew in the mid-teens year-over-year. From a vertical standpoint, our mix did not changed meaningfully this quarter, with government and education accounting for over 40% of the total, healthcare at a bit over 10%, manufacturing at approximately 10%, and retail, transportation and logistics approaching 10%. Services and subscription revenue was $94.9 million, up 6% year-over-year. This growth was largely driven by the strength of cloud subscription, up 33% year-over-year. Total Q2 recurring revenue, including maintenance, managed services and subscriptions was at $88 million, or 28% of total company revenue. The growth of cloud subscriptions and maintenance drove the total deferred revenue to $446 million, up 19% from the year ago quarter and 5% sequentially. Our gross margin came in at 58.5%, up 90 basis points sequentially and 30 basis points from the year ago quarter. This was mainly attributable to our product gross margin, which benefited from higher revenue and an improvement in supply chain and distribution costs, partially offset by a change in the product mix with higher contribution from Wireless. Our services and subscription gross margin was at 67% in Q2, consistent with both the prior year and prior quarter periods. Q2 operating expenses were $139 million, up from $127 million in the year ago quarter and from $135 million in Q1 '23, reflecting higher R&D investment and sales and marketing expense to support higher revenue growth. Total operating expense as a percentage of revenue was 43.7%, down 1.7 percentage points versus last quarter. All-in-all, our operating margin was 14.9%, the highest level ever achieved, up from 13.1% in the year ago quarter and 12.1% in Q1 '23. This quarter, we enjoyed record free cash flow of $67.5 million, driven by the strong increase in our EBITDA, as well as a reduction in operating working capital due primarily to strong collections. Our cash conversion cycle rose five days sequentially to 24 days. This strong cash flow enabled us to complete $50 million worth of share buybacks, while also reducing our net debt by $14 million to $59.5 million. Now turning to guidance. As we enter the second half, our confidence in the revenue outlook is supported by our product backlog of $542 million, our services and subscription deferred revenue balance of $446 million, as well as a product pipeline that is up double-digits year-over-year. We continue to expect that the reduction in expedite fees and shipping costs, combined with the full impact of our recent pricing actions will lead to a continued progressive recovery in gross margin throughout fiscal year '23. Against this backdrop, we expect for Q3 revenue to be in the range of $315 million to $325 million, gross margin to be in the range of 58% to 60%, operating expenses to be in the range of $140 million to $145 million, and earnings to be in the range of $31.1 million to $38.4 million, or $0.23 to $0.29 per diluted share. We expect to cross the 60% gross margin threshold in Q4. For full fiscal year '23, we expect revenue growth towards the high end of our 10% to 15% outlook, with an operating margin in the mid-teens. Great. Thank you very much. I knew there had to be somebody behind Remi doing all the work, so welcome to the call Cristina. It could have been just for Remi. I knew it had to be somebody else. I was hoping you could talk a little bit more in-depth about your commentary around backlog. I think you had said that you thought it would be up slightly in the December quarter, but obviously on a lower revenue guide. So it sounds like the overall orders were actually a little bit ahead of forecast or ahead of what would have built a little bit of backlog. But I think you'd also said that the March quarter, you would expect it to be flat to down here and then the June quarter down a little bit more. So the comment about the backlog relatively stable implies somewhat of a change in the rate of backlog usage bookings would have to be or orders would have to be a little bit stronger than what you had suggested, given the higher comments. So am I reading that correctly that you're actually a little bit more confident on new orders based off of what you said about the flatness of the backlog going into the June quarter? Hi, Alex. This is Ed and then Cristina jumps in behind if you want to add another comment, but I think that's right. So this is, for us, if we look at what happened as Cristina mentioned that, first half of last year we grew 16% in the first quarter and the first half of the year, and then we were up low-single digits in the first half of this year and then a lot of it got pulled-in to the first quarter. But our supply chain teams have done a great job. We talked about all the work that's going on behind the scenes. So we're seeing it loosen. So we've seen an acceleration of the release of products. And at the end of the day, we want to take care of our customers with some of that older aged backlog that's out there. So we took advantage of that. The second half for us, as you know, we see a lot of demand, and we're really confident and our teams are very confident of that demand. So we have booking strength we see in the second half of the year, and that should hold that backlog -- that should hold the backlog very, very stable through the second half of the year. So that also results in an increase in your services backlog as a result of the releases of services on those bookings. It does. I mean, the other thing that's happened here is that we have and you can see it from a bookings perspective, we talked about universal hardware platforms and those universal hardware platforms typically will have service attach and always subscription attach. So we have a backlog of subscription and services that will be released as we release the product backlog. Second question I have for you is on the inventory side of things. There is certainly a lot of costs that were inflated over the last year as a result of the supply constraints. When I look at your inventory up considerably over the last two years, is there a -- some higher priced inventory in there that needs to be worked down before the full leverage of the upside to universal and lower parts costs plays through? How do we think about the improved availability causing that inventory to come down driving up cash flow? Yeah. Well we -- yeah, at a high level, we have -- obviously the older inventory shipping out, newer inventory coming in, which is going to come in at the higher COGS and we are building up supply. And the inventory is correlated to getting more supply and we're anticipating getting more supply. So I think, there is a correlation there, and maybe I'll ask Cristina to comment overall inventory. Yeah. So at the inventory, I see is another sign of the improvement in the supply chain. So we were able to get more parts in and we're able to have more finished goods. So I think it will definitely lead to being able to ship more of the backlog. And that's a good sign from the supply chain. Yeah. The question really is on the cost of goods sold, relative to the inventory that was maybe inflated part costs to it. Is that in inventory and therefore has to be worked through before you get the benefit of falling parts costs as a result of improved supply chain? So the benefit that we'll see in our supply chain cost is really related to those incremental expedite fees and higher logistics costs that we've experienced through this challenging supply chain environment. The component costs themselves, we have seen inflation of that and we're not seeing that yet come back down. Yeah. And Alex, I think another consideration is that, there are two other key things that happened. So as a percentage of mix, Wireless was up in the quarter. And so, as the Wireless mix goes up, that tends to have a little bit of a drag on gross margin, as you know, campus switching is slightly higher margin in terms of mix. And I think underlying your question is also timing of when we sell out some of the aged inventory that we took orders before some of the price increases, and so that will help us as we move forward. I think that's what you were underlying your question there. As we move forward with newer orders that we have taken from customers, they will reflect more of the price increase and that will create a tailwind for gross margin going forward. So parts costs are roughly, I would say 2 percentage points to 3 percentage points above the normal percentage of revenue, as part of the standard COGS. And right now, we're not seeing -- we're basically expecting that trend to stay flat and then come down progressively through the next, I would say, three to four quarters. Yeah. Congrats on the strong quarter. My question has to do with the FY ‘24 language. I want to make sure, I'm understanding this. I think last quarter you talked about FY ‘24 growth in the range of 15% to 17% and this quarter at least in the press release the languages accelerated growth, so wanted to know if that 15% to 17% is still what you're talking about when you say accelerated growth or if it's something different? Yeah, Eric. I think at this stage of the game, we'll hang on to the long-term CAGR that we put out there as far as 14% to 17%. And so, it's that sort of mid to high teens number and we're very confident of that number going into '24. And the call here given the acceleration of supply and what we've seen here, so the combination of strength of demand that we're forecasting as far as bookings, as well as the supply release we're calling the high end of that 10% to 15% range for the second half of the year, but we do expect it to go up in fiscal '24. Okay. And then you talked about the health of the pipeline. I was wondering if you could take that down to your geographic levels and talk about USA, EMEA and APAC pipeline? It's interesting, Eric. It's strong across the board. We've been getting a lot of questions about, are we seeing softness? We've heard other companies talking about it kind of macro-tech in general. So we've drilled down and we've been doing RD (ph) level calls across all regions. And interestingly across the board globally, our teams are calling strength and it shows up in terms of the leadership and then the directors and literally our direct sellers are rolling up and what they're calling. In terms of the pipeline and our funnel analytics, we've got very good visibility and we're getting much better at calling numbers and we have this AI tool that we use that helps us call it. So I'm going to call it across the Board. There's not specific strength or weakness to call out, other than the recovery in APAC. Asia-Pacific and some of our markets there have been hit by currency, other issues and that -- we felt that this quarter, but the teams have a plan and we have new leadership in markets and we're expecting a really strong recovery in Asia Pacific. Thank you. One moment for our next question. Our next question comes from Mike Genovese with Rosenblatt Securities. Your line is open. Great. Thanks a lot. So there was a lot of positive commentary on the subscription and SaaS revenue growth, but the subscription growth went down to 30 from 60 in the quarter before. So can we just get more color on whether tough comps or timing issues, and what do you expect in the second half of the year on that subscription growth? Yeah. So, thanks, Mike. Yeah, subscription growth, if we look at quarter-over-quarter subscription growth, year-over-year subscription growth, the trends have been somewhat consistent, what we've call is a long-term range where we've said, you're going to see a 30% to 40% subscription growth. We have a lot of -- as you're well aware, we have a lot of our subscription in backlog. So it's a function of the timing of the release of backlog, and it's the timing of the release of backlog. And then, as you know, when we release subscription, you get -- there is a delay in terms of how you recognize revenue because of the accrual. So one of the things Cristina commented on, was the 38% growth in terms of the accrued subscription revenue, deferred revenue and then we think you'll see that rollout, but the long term model is, I'm sorry, 25% to 35% and that's the normalized level that, that I know we put out for our long-term guidance. And 33% fall is going to right in the middle there, but we would expect that to continue. Cristina, I don't know if you want to add other color to that? Yeah. It is in line with our guidance, long-term guidance. And so, that is according to expectations and there is a bit of a timing with regards to attached product as well. So some of our subscription bookings are attached to wireless bookings and so, there will be a little bit of fluctuation quarter-to-quarter due to that. Okay. Great. Thanks. And then I know this is hard to call out at this time and make an accurate forecast, but in terms of fiscal '24 gross margins versus fiscal '23 gross margins, I'd love to get your thoughts on, how -- roughly how many points of improvement that supply chain and other factors like software mix could drive in the gross margin for '24? Yeah. I'll take a shot at this Mike, and then open it up for the rest of the team, but we continue to see the step function. We are seeing a slightly higher concentration when we look at mix. Wireless comes in with a lower gross margin, then campus switching and data center switching, certainly. And then because of the strength of product that we're seeing, we wind up with more product mix, which has lower gross margin than our subscription and service revenue. So as a result, that's why we've tempered our outlook for the rest of the year. But we're very confident and crossing over that 60% gross margin number as we head into our fourth quarter of this year and we expect a step function to continue into fiscal '24. Exactly. We expect to hit 60% in Q4. We've seen a gradual progressive improvement in our gross margin throughout fiscal year '23. So roughly about a percentage -- 0.5 percentage point to 1 percentage point of improvement in each quarter. And we expect that trend to continue in fiscal year '24. I mentioned that unusual or an inflated costs related to the supply chain environments such as expedite fees, and higher than normal freight costs, we expect those to gradually come down and continue to come down through FY '24. So roughly, I would say that we expect gross margin to improve roughly 3 points to 4 points by the end of Q2 -- fiscal year '24. Thank you. One moment for our next question. We have a question from Greg Mesniaeff with West Park Capital. Your line is open. Yes. Thank you, and congrats on a good quarter. I have an R&D question for you guys. As you look at your product mix, and you look at component costs, the fact that they've gone up and they've remained sticky. What kind of initiatives are you -- do you have in place right now to basically engineer out some of the hardware component costs, particularly in switching and campus switching in areas where you know, it's kind of component heavy, if you will? Any insights on that would I think be kind of helpful to see how you can essentially move beyond some of the higher component costs that go into the products and the switches? Thanks. Yeah. Well, Greg, thanks for the question. I'll lead off. One of the things that I mentioned is that, during the quarter that we qualified an additional 37 component suppliers. And there is a question of our resiliency around availability and supply chain constraints. And then there's also the question around how we drive our gross margin through the qualification of new suppliers and new components and new parts. One of the lessons learned for us is that, we have the ability to enhance this qualification process and the qualification process that was solely focused on availability will be turned towards driving and improving gross margins as we go forward. So it's a good question. I can tell you, it's something that we're very focused on. Yeah. Greg that should be in the presentation. And if you look there, we talked about DSO in the 44 day range, it's on Page 14 of our… Thank you. Good morning. Just my first question is on your key verticals, I assume there is still positive. Any verticals that is turning negative? Hi, Dave. I think we have -- yeah, the one area which for us is a small percentage of our business, but you have seen some softness in service provider. I think you've probably heard that more broadly in the marketplace. We have some very targeted service provider customers and through the quarter, we think that some of the capital spending programs with some of the larger end-users has slowed down a bit. That being said, as we forecast the second half of the year, we're seeing healthier demand coming from our service provider team, in terms of the call for the second half. But that would be the one to call-out, otherwise, I would say, relative strength for us. The other high-level comment that I would make is that, we are in a position from being a somewhat smaller player with a lot of other larger players in the industry for us to take share. So in some of the verticals and we'll be coming out and announcing some wins that we've got, we've been able to win significant share in some of these markets, where there's a meaningful share shift that sort of transcends what's going on and maybe more the general macro sense, which will be coming out with. So, I would say in general, pretty steady across the board in terms of the verticals and service provider, which was soft. With our very focused applications, we see strengthening from where we were in the first half through the second half. And speaking of service providers on Ericsson, they talked about the 5G market a little bit choppy this year, especially first half. Do you still expect to achieve your target of $100 million in 5G, despite Ericsson's comments? We do. We still see strength. We don't think 5G is going away. We think there is a pause with some of the buyers, as they're tightening their budget, but the long-term opportunity is a resounding, yes. The service providers are going to upgrade their infrastructure. And fortunately, we're in a very strong position as part of that infrastructure upgrade. And so, we think that's the case. The other thing is that, they are more with Ericsson, they have more service providers in the queue. So in terms of the number of proof-of-concepts and then proof-of-concepts turning into a meaningful go-live launches, that funnel continues to build nicely. And any other potential customers in the pipeline that you can talk about or is it still the North America service provider and the European equipment vendor? Yeah. Those are the -- I mean, they remain the big two and what I would say is, we see more opportunities with both of those customers. As we look at service provider, we have a sell to. From a traditional IT perspective, we have a sell with where we're part of their solution from an OEM. And now we see opportunities to sell through to be their partner, their enterprise partner. And so, these are the three prongs that we're attacking the service provider market with. And there are significant growth opportunities that we see in the market. And my last question is, I may have missed it, but did you give out the backlog composition in the mix? I think, I would say that we would expect it to be fairly consistent with the overall business mix that we report. Hey. And Dave, I would just add that, you know, we did say in our prepared remarks that the backlog has a good contribution from universal platform products. And so, those are the newer products that we have come out to market with. So we did talk about that. Hey, guys. This is Tyler on behalf of Christian. Thanks for letting us ask a question. So I didn't hear and I was wondering if you could give any update, I think you said last quarter that you expected that your backlog would take multiple years to return to normalized levels. And it probably wouldn't be back to $50 million to $100 million type normalized level until fiscal '26. I guess, any update or [indiscernible] of that? Yeah. We still have the same outlook and the way we've guided that is, that we see backlog returning to normal by the last quarter of fiscal '25. And then sort of being normal as we enter '26. And so, that's how we model it. And that's how we've seen it. And it's a combination of strength of demand, because we continue to see strong bookings. And then also just this -- the release of backlog in terms of how we forecast supply chain. Thank you. And it looks like we have a follow-up. One moment. From Alex Henderson with Needham and Company. Your line is open. Great. Thanks. So I wanted to ask a question around the realized pricing and discounting. There was a lot of discussion about very steep price hikes over the last 18 months, pretty much out of everybody in the category as components were going up. But the realization of those prices, even as supply is starting to improve seems a little less than what we would have expected. And it sounds like there's probably a little bit more discounting going on as the economy is weakened, particularly out of your competitors. So can you talk a bit about what you're seeing in the pricing arena and how much of the price benefits that you've announced or increases you've announced are now being discounted out? Yeah. We're you know, that's always the phenomenon Alex, there's always a price increase and then a portion of the price increase gets discounted away. And so, it really is -- it's kind of a combination of art and science and trying to handicap and forecast that. One thing that I can say is that, the supply chain environment is complicated things. Because as we sell and we put orders into backlog, we have different vintage orders that have different levels of pricing in them, if that makes sense. So one of the things that we have done last quarter, and that we're looking to do this quarter is released a much older backlog, and that older backlog will not have as many of the pricing moves, if you will, or the price increases in the ASP. So that's part of kind of what we have to balance. Our view is that the margins are going to come. And we fully expect to see that the step function right now, given the mix issues that we talked about in the quarter, and then the March quarter, we see it stepping into the June quarter before we cross over 60%. I get it on the margin side, then you're pretty clear on your guidance there. I guess, my question really is how much of the revenue growth is a function of price versus volume, within the both the December quarter and back half outlook? Yeah, I think we would point to -- I think we would point to low to mid-single digits for that pricing number. The other comment that I'd make Alex is that the largest competitor in the industry has raised price. And fortunately for us, it creates an umbrella and gives us the flexibility to consider potential pricing moves as well. All right. Any thoughts on the trajectory of interest income and tax lines for the next couple of quarters? Obviously, your cash position is improving, your debt is coming down. Makes a little hard for us to calculate that number. What is the march expectation for interest and other income? And for that matter, any sense of the June quarter would be great as well. Yes. Thank you. So we expect interest expense to remain fairly stable as we do bring down our debt. So we don't see a large increase in that. And we're basically affecting our non-GAAP results with roughly an 18% to 19% effective tax rate. So the net of the numbers, because we don't see the components of it. The net of the numbers, because we don't see the components of it. The net and that number on the interest and other income line should be continuing at around $2.9 million expense? Is that what you're saying? Okay. So the rate -- the floating rate on the debt is going up and offsetting the floating rate on the interest -- the cash balances. Alex, the other thing I would just mention is that the share count, you'll see a drop in share count based on the share repurchases during the second quarter. Great. Thank you. Actually, before I get off of one last question that what are you seeing in terms of employee retention and employee wage rates inflation? Well, this is the quarter where we have, from a benefits perspective and from a merit increase, this is when that gets whizzled into our numbers. But you're familiar with that, because that's always the March quarter. We are in a really strong position and really fortunate we have first of all, our turnover is very low, the lowest among the tech industry peers. We do a lot of comparison, evaluation and analysis and our voluntary turnover is incredibly low. And along with that we are in the market and we're hiring, because we're investing in growth, because we have this unique growth opportunity over the next several years, and we have a lot of different growth opportunities that we can invest in. So Extreme has been hiring and our turnover has been low. Thank you. I'd like to thank everybody for participating in the call today. Obviously, it's a record quarter for Extreme, record revenue, record cash flow. We just missed that 15% operating income number and the momentum as it relates to our bookings and our customer growth continues to be very strong. So we have a lot of different people listening in the call, so shout out to all the Extreme employees, our partner community that's helping us drive growth, our end users out there and of course, all the investors for participating on the call today. We would encourage everyone to participate in the upcoming investor conferences over the next couple of months. And as I said before, there's never been a better time to be at Extreme either employee, partner, customer, investor. And another welcome to Cristina, for joining us today on the call and stepping into her new role. Thanks, everybody. Have a great day.
EarningCall_1430
[Foreign Language] Good morning to everybody. A warm welcome to all of those attending the presentation of Inditex's results for the Interim 9 months 2022. I am Marcos López, Capital Markets Director. The presentation will be chaired by Inditex's CEO, Oscar García Maceiras; also with us is our CFO, Ignacio Fernández. The presentation will be followed by a Q&A session, starting with the questions received on the telephone and then those received through the webcast platform. Good morning, and welcome to our results presentation. It is my pleasure to join you today. In the first nine months of 2022, our business model has continued to deliver a strong growth. This performance relies on the 4 key pillars that we have introduced to you previously, our product offering, a unique customer experience, our focus on sustainability and the talent and commitment of our people. We have had a very strong sales performance in the 9 months of 2022, and this performance has continued beyond this period with autumn/winter collections very well received by our customers. The execution of the business model has also been remarkable despite a challenging environment. These are the reasons why sales, EBITDA and net income have reached historic highs, both in the first 9 months and in the third quarter of 2022. Our operating performance places us in a robust financial position. We have generated significant free cash flow, taking our net cash position to EUR 10 billion. All this in conjunction with a well-established dividend policy. Let me highlight some key figures for the year thus far, marked by a strong execution of the model. Sales reached EUR 23 billion, 19% higher versus the 9 months of 2021. Sales were positive in all geographical areas and in store and online. The control of operating expenses was rigorous as they grew well below sales growth. On the bottom line, net income increased 24% to EUR 3.1 billion, and our operations continue to generate a strong cash flow. Our diversified presence in 215 markets with low market penetration allows us to enjoy significant global growth opportunities. We have complete confidence in the ability to grow our unique business model. Thank you, Oscar. As you can see in our release, Inditex had a very strong execution in the 9 months of 2022, despite the challenging environment. As Oscar mentioned a few moments ago, sales EBITDA net income reached historic highs in the 9 months and in the quarter. Sales have progressed strongly at plus 19%. We have managed the supply chain actively, and this has driven a healthy gross margin. Operating expenses have, of course, been managed rigorously. Net income increased 24% to EUR 3.1 billion. We continue generating a significant free cash flow, taking our net cash position to EUR 10 billion. Let me reiterate that sales have progressed very nicely at plus 19%, reaching EUR 23.1 billion and grew 20% in constant currency. Sales have been positive across all regions. In the first month of 2022, Inditex's traffic and store sales increased significantly. This trend continue as the year progress with store differentiation being key. Online sales also progress satisfactory, over and above the record 9 months of 2021. Based on current exchange rates, we expect a natural currency impact on sales for the full year 2022. In the 9 months of 2022, gross profit increased 19% to reach EUR 13.5 billion and demonstrated a healthy execution of the business model. The gross margin reached 58.7%. Based on current information, we expect a stable gross margin of plus/minus 50 basis points for 2022. There has been very rigorous control of operating expenses across all departments and business areas. Operating expenses increased below sales growth over the 9 months of 2022. Including all these charges, operating expenses grew 4 percentage points below sales growth. Inditex temporarily accelerated Autumn/Winter inventory inflows in order in the face of possible supply chain tensions throughout 2022. In order to increase product availability without any change to commitment levels. Due to this reason, inventory as of the 31st of October 2022 increased 27%. The Autumn/Winter inventory is considered to be of high quality. As of the 8th of December 2022, inventory levels were 15% higher. This assumes, in conjunction with the strong cash flow, took the net cash position to EUR 10 billion. Thank you. Over the 9 months of 2022, we have continued with very strong expansion. We have opened stores in 30 different markets and have progressed with optimization activities across all concepts. We are pleased with the execution of the concepts over the 9 months. Store sales across all concepts have been robust. Online sales are above the record levels over the 9 months of 2021. Zara has generated an exceptional performance over the period. All the concepts have progressed strongly, especially Pull&Bear, Stradivarius and Bershka. Thank you. I would like to comment on some initiatives this season, which are driving the increasing levels of differentiation we are seeing. Key priorities continue to be to increase the appeal of our fashion proposition and to offer our customers a unique experience. We continue providing the latest fashion in a fully integrated way. A good example of this is Zara Woman A moment in time collection; Zara Woman Cruise collection; Zara Man The knit; Zara Kids Autumn/Winter; Zara Home's A sense of Christmas; Pull&Bear's Night out; Massimo Dutti's Limited edition; Bershka's Art series; Stradivarius Unstoppable black; and finally, Oysho's Ski collection. In terms of the customer experience, I would like to highlight some key store projects of 2022, like the new Zara store at Juan d'Austria in Valencia, the enlargement of the Zara store at Busan in South Korea, or the enlargement of the Zara store at Kyoto in Japan. A key project for next season will be the relocation of the Zara store at Paris Champs-Élysées in spring. The new store will extend over 3,600 square meters and will offer the latest fashion in the most up-to-date image. Like our most relevant flagships stores recently opened, will include dedicated spaces for lingerie, shoes and handbags, the Origins collection, athletics and newborns. It will also include all the feature that allow a complete digital experience. We work to provide a unique customer offering on our platforms. One example of this is Store Mode. Store Mode has already been rolled out to around 60 markets. Let's now talk about sustainability. As per the sustainability roadmaps, Inditex is on track to deliver upon all the targets set for 2022, 2023 and 2025. Our strategy is particularly focused on 2 pillars: innovation through our Sustainability Innovation Hub and circularity. On the 30th of November 2022, Inditex launched the new detergent, The Laundry by Zara Home, which is available in stores and online platforms in more than 25 markets. Developed jointly by Inditex and BASF, the innovative solution reduces microfibers released by up to 80%. Detergent formula features a combination of efficient ingredients, particularly suitable for washing at low temperatures and thereby reduces the carbon footprint and extends the life of the textiles. The developed solution can also be adjusted to enable the use of this technology by other detergent manufacturers, and shows the effectiveness of cross-industry collaboration. On the 30th of November 2022, we launched Zara Pre-owned in the United Kingdom, a pioneering integrated platform available through Zara stores, zara.com and its mobile app. The initiative is a new step in our approach to circularity by focusing on repair, resell and donation. Through this platform, customers will be able to extend the life cycle of used clothing and will contribute to the reduction of waste. We continue to deliver upon our long-term goals. We offer a unique fashion proposition defined by creativity, design, quality and beauty. The continuous optimization of the customer experience is key to our approach. Sustainability and digitalization also remain at the core of our strategy. The talent, commitment and passion of our teams all around the globe will always be key to our competitive edge. I would like to reiterate that our main priority is always to invest in the future profitable growth of the business. Additionally, we will, of course, continue with our dividend policy. The strength of the fully integrated business model has been clear in recent times. We plan to continue developing these key long-term advantages in order to maximize organic growth. A key focus is on high-quality stores with the aim that they'll be fully integrated, digital and eco-efficient. As part of the strategy, we also expect online sales to exceed 30% of group sales by 2024. Stable gross margins have always been a key focus for us. As we continue to invest in the business, we expect to deliver a strong free cash flow. Ordinary capital expenditure should reach EUR 1.1 billion for 2022, which is driving differentiation and digitalization. We enjoy a global presence, having operations in 215 markets with low market share in what remains a highly fragmented sector. Based on our unique fashion proposition and the factors that I have mentioned earlier, the model is operating at full pace, and we enjoy very significant opportunities through both organic growth and expansion. Autumn/Winter collections have been very well received by our customers. The store and online sales in constant currency between the 1st of November and 8th of December 2022 increased 12% versus the record period in 2021. The final dividend for 2021 of EUR 0.465 was paid on the 2nd of November 2022. Our dividend policy of 60% ordinary payout and bonus dividends remains in place. As a reminder, the Board of Directors also proposed a total bonus of dividend of EUR 0.40 per share to be paid in relation to the fiscal 2022 results. Thank you all for attending. That concludes our presentation for today. We will be happy to answer any questions you may have. I've got three questions, please. First of all, what was the increase in online sales in the third quarter? Second question, have you considered launching a marketplace on Zara or any other website? And then finally, please could you update us on the average basket size at Zara these days including sales tax and before returns? Okay, regarding your first question about online. I think that in the presentation, we mentioned that online sales are positive, not only in the quarter but also on the 9 months over the record in the figure we obtained last year. So I think this is a very positive message. Stores clearly positive online is clearly positive. So very, very healthy execution. Regarding marketplaces, we have not changed our strategy. We remain exactly the same, and we have no plans to launch a marketplace in the short to medium term. And regarding the average basket, I would say that the most important factor is the strong execution of the model over these 9 months, you've seen that sales have increased 19%. And also, I would like to comment very clearly on the trading update of 12% that we have obtained from the 1st of November to the 8th of December, which is not only over the record period of 2021, but is at that higher over the third quarter 2022. In terms of pricing, there are no updates as what we mentioned that, in the situations where there are issues in which, especially on the cost side, that we require to adjust prices to defend our gross margin. We do it always on a very progressive way. We mentioned at the beginning of the year that for this year and based on the what the situation in the market, we were going to adjust prices by the mid-single digit. So nothing material. And again, it's a very, very focused exercise. It's not by -- it's not across the board. It's by a family of product, by a family of fashion components. And this remains the case. I mean you can -- you have to -- basically, what we have mentioned in the presentation is that the execution of the business model we had is based on the strength of the fashion collections and the customer experience in our stores and online. A couple from me, please. First of all, how should we interpret the reduction in cash and increase in short-term investments in the net cash line? Should we expect higher financial income or much higher financial income in Q4 and next year? And then the second one is on inventory. To what extent has the recent inventory reduction as the result of any increased discounting or participation in Black Friday type activity? Well, regarding cash, as you can imagine, our treasury is always trying to find the best opportunities for investment of our cash and this is why we tactically moved from short-term investments into cash and vice versa. Obviously, with higher interest rates, it's more interesting to try to achieve a bit more of profitability, but we don't expect very significant changes for the -- on a quarterly basis. But we always try to obtain the best profitability for our cash. And regarding the more discounting, this is not the case. Our participation in events like Black Friday is very limited. Our key focus is to sell the latest fashions at full price. So nothing material versus last year. One question. I think you said that OpEx growth year-to-date has been below top line growth. But if I look at the numbers, if I add it up correctly, I think OpEx growth was ahead of top line growth in Q3. I was just wondering if you could provide some color on that. Absolutely. Basically, what we have mentioned in the presentation is clearly that if you include all the lease charges into operating expenses, then operating expenses grew 4 percentage points below sales. Clearly, this is just a result of the IFRS accounting that you know very well. But there was clearly leverage in this first 9 months of the -- we've seen that mistake in some of the commentators in the market. But clearly, you have to understand that to compare apples-to-apples you have to add all the lease charges to operating expenses. One with still two related parts, please. First of all, thanks for your comments in terms of the discounting. May I just ask with regards to Q4 then, if it's not on discounting, what actually are you expecting to sort of swing that margin? Because I think in terms of your full year guidance, it would imply a range of something like minus 150 to plus 150 for Q4 alone. So just what are the swing factors there, please? And then should we still expect inventory to be elevated, i.e., sort of bringing them in early when we come to the end of the final quarter, please? Okay, I will start with the second one. As we have updated you on the 8th of December, our inventory is just 15% higher, and we have provided you a trading update of 12%. I think this is the best way to put the situation into the context and this is why we are reiterating the gross margin for the year of vision of a stable gross margin, which for us always includes the minus or plus 50 basis points comment to adjust that. But there are no changes in our guidance for the year. Could you just comment maybe about how you see the external factors on supply chain costs for the year ahead? Do you think you'll have to raise prices again by mid-single digits in the next season to maintain and protect gross margins? Well, let us focus on the current season. We are still in the middle of the Autumn/Winter season, and we'll talk about those factors in March. What we can tell you is that as of today, despite the challenging environment that we have described and that you know well, with so many factors affecting gross margins, OpEx, I think the focus is totally on the current season, and this is why we can provide you with these numbers in the sense that we have obtained these results and we are able to focus on stable gross margin for the year with a 12% growth in the trading update, 15% inventory position. So completely focused on the current season and then in March, we'll talk about next year. It's Nick Coulter from Citi. A slightly different lens on SG&A perhaps. If you could talk to some of the initiatives you have in place to control cost inflation in your SG&A, please? And perhaps why that should continue into the coming quarters? Well, probably what we should talk is about two things. I think the first one is that the company has a total focus on executing in a disciplined manner, and this is not something that we change in every quarter. We clearly try to obtain all the efficiencies basically through the efforts of our people and also through technology, right? And these factors combined with the business model that we have, which combines stores and online in a very effective manner. In the presentation, we talk about, for example, the store mode now present in 60 countries. We continue to obtaining efficiencies all the time. And this is why in these 9 months, there is 4 percentage points of leverage in terms of OpEx versus sales. Our focus is always to try to maximize sales at full price, executing the model with quality, with interesting fashions, with constant drops of new collections. And this is what is delivering the type of returns that you are seeing. We're going to go over to webcast questions now. There have been a number of webcast questions today, the first of which is can you tell us a little bit more, please, Oscar, about the Zara pre-owned initiative? Well, thanks for the question. Zara pre-owned forms part of our commitment to circularity, embedded in our sustainability strategy. As we have already mentioned, it's currently available to customers in the U.K., allowing them to extend the use of life of clothes through repair, resell and donations. The repair service is available in all the stores and are now also online. It's designed to help customers to extend the life of the fashion. In the case of customer-to-customer resell platform, this is a space where customers can sell and buy brand products from any season from other customers. And the platform provides help with photos and information on the original products. Regarding donation service, customers can donate clothes by requesting a home collection. The service, which supplements our in-store clothing collection program beams ensures that all products collected are donated to local NGOs, we work with to support the development of projects in local communities. Our target, our ambition is to deploy this program to more core markets during 2023. Thank you. The next question on the webcast platform. Can you provide some comment on the performance in the U.S.A. and China, perhaps? Well, the sales progression in the 9 months was very positive from a global basis up 19.3%, as you know, with a strong growth in all geographic regions. The sales evolution of the different countries, of course, related to the timing of the temporary lockdowns both in this period, as well as in the comparable period last year. Regarding the U.S., the key issue in 2022 so far has been the strong rebound in in-store traffic and in-store sales. We are very happy with our performance in the Americas, so far this year, and the U.S. is already our second largest market. And we continue to see very strong growth opportunities there. In the case of China, well, has been challenging this year due to the rolling restrictions across the country throughout the 9 months. But we remain absolutely confident about our opportunities there in the medium to long term. Fashion demand continues to be strong in China. And for sure, it will remain a core market for us for Inditex. The next question. This year, you have opened large flagship stores in Plaza de España, Madrid and Battersea in London. Can you talk a little bit more about the sales development in these stores, please? Well, the stores in Plaza de España, in Madrid and Battersea in London are great examples of the kind of stores that we are opening now. Large flagship stores in the best global retail locations, fully digital and sustainable. Both stores include all the features of our digital store mode allowing a complete digital experience, and spaces for lingerie, newborns, et cetera, et cetera. The sales since opening has been very strong as they are the kind of stores that gives the customer experience that's worth going to the store for. Our idea is to keep on opening this type of stores in another prime locations such as Paris Champs-Élysées as we have already mentioned during our presentation. Thank you to all of those participating in the presentation today. For any additional questions you may have, please get in touch with our capital markets department, and we'll welcome you back in March 2023 for the full year results.
EarningCall_1431
Good morning, and welcome to the Guaranty Bancshares' Fourth Quarter 2022 Earnings Call. My name is Nona Branch, and I will be your operator for today's call. This call is being recorded. After the prepared remarks, there will be a Q&A session. Our host for today's call will be Ty Abston, Chairman and Chief Executive Officer of the Company; Cappy Payne, Senior Executive Vice President and Chief Financial Officer of the Company; Shalene Jacobson, Executive Vice President and Chief Financial Officer of the Bank. Thank you, Nona. Good morning, everyone, and again welcome to our fourth quarter earnings call for Guaranty Bancshares. We did have a year that we're very proud of. Our quarter did have some noise in it that we're going to go over explain our presentation. And then we're going to talk a little bit about our projections for 2023. We'll get into our slide deck and go through that and then we'll open up for Q&A. Okay. Thank you, Ty. Let's briefly hit some of the highlights of the balance sheet first and I'll go over the income statement. We do have some of those highlights on the slide deck here, if you're looking on your PC. Our total assets for the year ended at $3.4 billion that was down for the quarter, about $39 million, but it is up for the year $265 million. Lot of that came from an increase in loans. We had a really good year and loan growth. We were up for the quarter $112 million, this is ex-PPP and warehouse lending. And for the year, we were up $553 million, about 30%. And look at some of the details of that, we did have growth in all four of our regions. So we were proud of that and do have emphasis in activity in all four of those regions. You can see in the earnings release, we do list a loan composition chart. And, of course, most of that loan growth is real estate based. And again, you can see the components being CRE, construction, development and so forth. On the bond portfolio, it did show a decrease during the quarter. Like, we told you last earnings release, we had about $120 million in treasury, short-term and treasuries that matured. They were at a pretty low rate. So actually the yield on the portfolio increased, but the volume was down about $133 million for the quarter. Year-to-date though, our year-end balances were up about $175 million year-over-year in the bond portfolio. Then looking at the liability slide, probably the notable change, obviously, is what people are looking at in deposits. We did have a deposit decrease during the quarter of $109 million about $89 million of that, largest majority was in non-interest bearing DDA balances and about $20 million in interest bearing balances. Some of that was just -- we knew some of that was coming. There's just a restructuring and just a positioning of some funds that got invested elsewhere. I'll talk a little bit about some of the calls related to that, but kind of a comment on there. We normally see public fund money increased during the fourth quarter. We did see it increase just not as much as normal and probably that's indicative of what we're seeing, a lot of a lot of our customers at least being faced with is alternative investment rates on other investments. Public fund money is most of it's contracted at a certain rate, and a lot of what they're seeing was a lot higher than what they -- what our contracted rate is, so some of that money went elsewhere. Again, our public fund money is not a large part of our deposits, about 11% $300 million over -- on our $2.7 billion in total deposits. But I think it's just kind of just to show you what we're all seeing in the banking world as far as competition. Our year-to-date, our deposits were up about $10 million and our DDA balances actually were up $38 million in total year-over-year. So our non-interest bearing balances still account for 39% of our total deposits, which again helps in that funding cost. Our Federal Home Loan Bank borrowings did increase for the quarter. That's going to be driven mainly by that loan growth and some deposit decrease during fourth quarter. And at year end, they were $290 million in total fundings from Federal Home Loan Bank. Our shareholder equity increased obviously due -- in the quarter due to earnings, offset by the dividend that we did pay. We paid another $0.22 cash dividend. We also did have a slight improvement in our accumulated other comprehensive income, which is the unrealized loss in our bond portfolio. So our tangible common equity ended the year at a ratio show of 7.87% down a little bit during the year due to that significant increase in the unrealized loss in our bond portfolio, accumulate other comprehensive income. That $0.22 dividend that we paid during the quarter made a total of $0.88 for the year, that's up 10% year-over-year. And looking back at our history, we've got about a 30 plus year history of increasing annual dividend. I think all the two years of those 30 plus years, we did not increase it. Every other year, we increase it. Those two years, we just left them flat. We did not decrease them, but we didn't increase them. And that $0.88 dividend based on current yield is about -- based on current price is about a 2.5% yield on that return. Then looking over at the income statement, you can see our fourth quarter net earnings were $8 million which was down from the previous three quarters, that $8 million is $0.67 per share. That the decrease or the significant event during the quarter was related to a provision that we made of $2.8 million due to our CECL modeling. Shalene will give you a little more detail on that in just a minute, so I'll not talk the detail on it. But because of that, that event, if you look at our pre-provision, pre-tax pre-PPP activity, which is our net core earnings. We've been putting this chart in there each quarter for the last two years. And you see that our quarterly earnings pre-provision pre-tax were $12.6 million for the quarter. Our year-to-date was $50.2 million and that compares from previous year fourth quarter of $10 million and previous year 2021 of $39 million. So year-over-year, that's about $11.2 million increase, which is 29%. So then looking at our year-to-date return on average assets and again on net earnings, we were 1.24% stated earnings, 1.24% for 2022, for the year compared to 1.36% for 2021. Again, a significant factor in that change would be the difference in the 2022 provision that we made versus the 2021 release that we did, which those two components were a swing of about $3.9 million. Return on average equity for the year was 13.76% compared to 13.72% in 20 21. Again, we had we had really good earnings. As Ty said, we're proud of the year we did and both these two years 2022 and 2021, the net earnings were significantly higher than previous years. So then looking at the components, like, what everyone's focused on, is our net interest margin. In Q4, it did show a decrease of 2 basis points. It was 3.57% down from 3.59% in linked quarter, but up from the same quarter last year of 18 basis points. Loan yields are an increasing nicely as rates are rising, and we talk about that in the earnings release. Shalene will again talk some more detail on that and what rates are currently doing. But I think probably more of the focused attention is on our cost of interest bearing deposits, probably. Some we look at all-the-time and made some decisions on this quarter that we're not exactly what we had projected as didn't, as I think as many banks though, saw we did see that outflow of deposits and to remain competitive we increased our cost of interest bearing deposits for the quarter more than we had projected that we thought we were going to do prior to the quarter. The interest cost of interest bearing deposits for the quarter were 108 basis points. In Q4, that's up from 59 basis points in Q3, significant increase, but those are some decisions we made to remain competitive in the various markets that we're in, and we're seeing all sorts of competition, both in small bank and big, and larger banks, and then to protect our existing core deposit base. And I think we put in the press release our interest bearing cost of deposits beta increased 40% during the quarter, which is significantly higher because we made those decisions both in increasing some CD rates and our money market rates more than what we had projected. I guess a note to point out when using our non-interest bearing balances, the total cost of funds is 64 basis points. Again, we put that in the earnings release, that's up from 35 basis points linked quarter. So the -- so I'd make a total deposit beta increase of 23%. And looking at non-interest income, it still remains lower than what we saw in 2021 and the first half of 2022. If you look out the -- if you take out the extraordinary items, Q3 and Q4 were very consistent with each other. I think we're going to continue to have challenges in our non-interest income category back certainly last year when the loan -- the mortgage rates were lower. We had a lot more gain on sale. If we look at year-over-year, our gain on sale in ‘22 was 55% lower than it was in ’21, that's about a $3 million swing. So we're projecting the lower volume going forward and mortgage activity and related fee income as we look at 2023. We did have some positive trends other than that on the non-interest income though. The debit card volume continues to increase and show good volumes. And our fiduciary income is pretty stable even in an unsteady stock market that we've experienced in the last half of 2022. On the expense side, we did have a little bit of elevated expenses in Q4, which sometimes will traditionally we do. We -- each year and we give raises in the fourth quarter starting in the first part of the fourth quarter in October. As we did this year when they're warranted, they were generally higher -- the razors were generally higher this year than what we've seen in prior years, obviously due to inflation and really just the competitive pressures that we're seeing in some staff positions. Our health care costs this year, as we told you in prior quarters, up a little bit this year over last year. So we had a little bit of catch up in Q4 to be properly funded period (ph). And then the other category that you'll notice in there is our software, our technology. We're constantly looking at our software providers and opportunity, and we did make some upgrades in our core and other systems that added some cost in that category. So that's a recap of the income statement. Thank you, Cappy. Next, I'll cover some of the highlights of our loan portfolio credit quality and the allowance for credit losses. As Cappy mentioned, our loan demand continued to be strong in the fourth quarter because loans in the pipeline from earlier in 2022 continued to close and fund up during the quarter, but our pipeline is certainly slowing down now, partially because of the higher rates, but also because we're really tapping the brakes on growth as we prepare for a likely downturn in the near future. As you all know, the Texas economy is still doing relatively well, but we aren't totally immune to downturns either. Therefore, we're tightening our underwriting standards and really being conservative with balance sheet growth for 2023 and Ty will provide a few more thoughts on the loan outlook for 2023 on the next slide in a few minutes. Overall, our loan yields are trending upwards. Our weighted average loan yields increased this quarter to 5.2% on the total portfolio, which is up from 4.96% in the third quarter. But the weighted average rate of new loan originations in the fourth quarter was 6.53% which is 88 basis points higher than the weighted average rate of 5.65, that was booked in the third quarter. And then in December, after the additional Fed hikes, we've been booking loans closer to the 7.5% rate on average. Our next bullet talks a bit about rate sensitivity of our loans. We have around $1.5 billion of loans that are fully floating or that are adjustable at various states in the future. Of the $1.5 billion, $256 million is fully floating and the rest is adjustable at future dates. Of the $1.3 that's adjustable of future dates, about $213 of that is contractually set to adjust during 2023 along again with the $256 of fully floating loans. Non-performing assets continue to remain relatively low at 0.32% compared to 0.28% in the prior quarter. A large portion of our non-performing assets, which are primarily non-accrual loans, consisted the four loans I've mentioned in prior quarters that were acquired from Westbound Bank back in 2018. Those four loans are 75% SBA guaranteed and they're collateralized by two loans or two hotels in Houston. The loans have total balances of $6.7 million of which are non-guaranteed exposures $1.7 million and we've got about $1 million reserved on those. We don't really expect there to be any material loss, if there is any loss on those as we continue to work through those problem loans. And then we also have a new $1.4 million land loan that was downgraded to non-accrual during the fourth quarter. The loan has low LTV and we expect the guarantors who we believe are pretty strong to pay off that loan in the very near future. So we don't expect any losses on that one either. Our net charge-offs and our net charge-offs to average loans ratio also continue to be very low this quarter. Next step is the allowance for credit losses. As Cappy mentioned, we had a $2.8 million provision for credit losses during the fourth quarter. We also had a $600,000 provision in Q3. We didn't have any provision in Q2, and we had $1.25 million release in the first quarter. So interesting how much can change in a year, but the total provision expense for 2022 ended up being $2.15 million for the year. So in addition to the loan growth during the quarter, we adjusted our CECL model to incorporate economic forecasts for a recession during 2023. In the fourth quarter, there appeared to be consensus among economists that a recession would occur. And there was even a survey was published by The Wall Street Journal back in October that cited 65% of the economists that they surveyed who expected a recession. So that consensus in the fourth quarter among other factors that we looked at provided us with greater support for adjusting our forecasts as well. However, we've historically had very minimal losses in prior downturns, and we really don't anticipate any significant losses during this potential downturn either. Our ACL coverage was 1.34% of total loans at the end of the quarter compared to 1.29% in the prior quarter. So, thanks, Shalene. So for the coming year, like, we've been saying, we're anticipating slower growth, the loan growth we had in fourth quarter really was those were credits primarily that were approved in the first half of ‘22 that have been funding up their equity portion. So that's really a majority of that. We are seeing a slower pipeline in ‘23 as we would expect. Like Shalene said, our state is overall doing well, but it going to slow here, like every other part of the country. We are seeing deposit challenges. We do, a big part of our models as we do have a strong core deposit base, but like everyone else, we're having to compete with the market and we're in markets where banks are paying pretty aggressive rates. While we're not leading that, we're certainly defending our core deposits because a lot of depositors quite frankly have been earning next to nothing in the last few years and are ready to get some yield. And they're also looking at what the treasury market is offering. And so we've seen lot of liquidity being pulled out of the system just in the treasury market where people are moving into treasuries that normally wouldn't. So we expect some net interest margin compression in ‘23. We think it's manageable, but we just -- it makes sense to us that we're going to continue to see those as we continue to reprice loans, but we also see our liabilities and deposits cost us more. We did have good earnings in ‘22 as we mentioned. Our goal when we started the year was to try to improve on ‘21 because ‘21 had $5 million or $6 million extraordinary income. Once we saw we looped that, then we felt it was prudent to go ahead and look at our factors and our CECL model going into ‘23. And so that's what we did in the last quarter. And like Shalene said, we do think that it's a real strength that our ALCI (ph) is very manageable. And not only where we are today, but also even where we would look -- what we would look like and shock an additional 100 and 150 basis points increase in rates. Very manageable, which means our capital continues to be very strong. Thank you, Ty. It is now time for our Q&A session of our call. Our first call will be from Michael Rose with Raymond James. Michael, you can unmute. Good morning. Thanks for taking my questions. Hope you're well and Happy New Year. Just wanted to obviously dig into the deposit discussion. I understand that the cost of interest bearing deposits were certainly up. Do you have a sense for what they were at the end of the year? And then kind of as a corollary to that, kind of what gives you confidence that you can expect balances to kind of be stabilized to maybe, have some slight pressure here. I mean, would you expect to fill with some higher cost learning so sources just given kind of the pressure on betas and costs and things like that. And I just wanted to get some context there. Thanks. Well, I'll talk about the deposit balance, Michael. I think, well, we're seeing and we're putting emphasis on our [indiscernible] with our production people is to focus more on deposits and loans. I think we'll -- we're still out there trying to grow our deposits and gain customer bigger customer base. So I think we'll continue to have challenges with the run offshore that we talked about with either alternative investment or increased funding cost because they put the money into a CD or something that they hadn't been in the last few year, but our emphasis will continue to be on our production people who go out there and get more customers. Yeah. Michael, I would just add to that. I mean, we're -- like every bank, I mean, we're seeing real pressure on the deposit side. We do have a core funding source in East Texas, but we're seeing deposit pressure out there too. It is still various. We still have a very stable deposit platform and we've been playing somewhat defensive with our rates. But this fourth quarter, we decided to be a little more aggressive and try to get in front of it. So we think we've slowed that down, but we still have quite a bit of our deposit base nearly 40% in DDA. So non-maturing deposits continue to be a strong part of our overall deposit structure, but we're going to defend our core relationships because a lot of it is just the reality that customers haven't seen any yield in three or four years and they're looking forward. And so even if you have core -- strong core funding base, you're going to have real headwinds when it comes to your funding cost with everything going on in the velocity of increase in rates that we've seen in the last few months. Okay. And maybe just kind of a follow-up to that. The margin was down a little bit Q-on-Q, but it seems like with maybe some of the other balance sheet actions even with the deposit pressure that you would expect the margin to maybe move up a few basis points because the slide reads plateau in the second quarter. And then maybe fall from there just directionally, is that kind of a way we should probably be thinking about it? That's generally what we're thinking, Michael. I think we'll pulled off a little bit on some details on that going forward just because we don't know the extent of how we're going to react with rate changes in the next few months too. Okay. And then maybe just one more for me. I think we can kind of figure out what the expenses are based on the expense to asset guide. But just on the fee income, obviously, some greater headwinds. You guys had kind of talked about it, I believe it was the range of, 22 to -- $23 million to $24 million for fee income next quarter, but it sounds like it's going to be a little bit less than that just given some of the market pressures and other things that you mentioned in your prepared remarks. Do you have kind of an updated range for what that could be for 2023? Thanks. I think we're going to be in the 22 to 23 range on fee income. That is what we have budgeted going forward. I just wanted to start with the expense base. Your guidance of 2.5% of assets is basically where you were at in the fourth quarter and you're not expecting much asset growth in 2023. So that, that kind of backs in the flat expenses versus the 4Q run rate, which I don't know, maybe seems a little optimistic just given the inflation headwinds. But is that the right way to think about it? Maybe expenses will be flat from here $10? From Q4, yeah, Brady. I think that's our -- that's what we're looking at in 2023 based on no -- or certainly a lot less growth in assets. So that 2.5, we're comfortable with the 2.5% guidance. But Brady, let me add this to that. I mean, across the board, we see headwinds with our expenses. We see headwinds with fee income and with NIM. And I think that's pretty universal in my opinion with what banks are going to be faced within ‘23. And it'll be up to us to go through that and create a good return. But you just – there's headwinds really in all of those key areas of our balance sheet and income statement and so that's we're a little less optimistic as far as just projecting that of where things go land in ‘23, because of the unknowns with where these rates are going, how they're going to settle out. Okay. All right. And then I know you all made some changes in your restructure pieces of mortgage and SBA and fee income. Is there anything notably different that we'll see out of those two segments this year. I know both are facing headwinds, but I know you've restructure both of those groups. Anything we should expect in that for this year? Okay. Great. Thanks. Cappy, I think you mentioned previously there were some treasuries that matured in the fourth quarter. Any more color on when those when those matured? Was it kind of throughout the quarter or was it weighted towards the front half or back half? And then what was the average yield on those treasuries that matured in the fourth quarter? We had $70 million mature on November 30 and another $20 million, I believe, that matured on November 24. I don't have the yields in front of me, but I can get that to you. That was really short term treasuries bought in the first of the year. So, yeah, I think it will be a low yield. Okay. And I think in the deck, you also talked about more securities maturing in 2023. Is any more -- anymore color on that, is it throughout the year kind of consistently or is it weighted towards the front half or back half of the year? The treasuries are weighted towards the front half of the year. I believe they're about $50 million. I'm pulling that up though so I can let you guys know if you have another question in the meantime. Got it. Okay. Well, I can shift over to loan growth, I guess, to buy Shalene some time here. But on the long… Sorry. I was able to pull it up real quick. So we've got $50 million in treasuries that are maturing in March, April, and May, and then another $20 million in September. And the ones that matured in November, the yield on one was 0.666 and the other was 0.880. And then the loan growth that we talked about before just any more color, should we assume the loan growth is going to be stronger in the front half of the year versus the back half versus what you see right now? You mentioned kind of intentional slowing of that from some of your borrowers. Just even more color on kind of the pace of it throughout the year. I think that's fair to look at it that way, Matt, is that loan growth that we have would be probably the first half of the year and be slight to a possible decline in the second half of the year is depending on how things play out. Okay. And then just I'm also curious about your the strategy around the FHLB advance. I think it's $209 million (ph) sounds like you could kind of maintain that balance for a while, but would love to appreciate maybe the puts and takes and kind of what's in the budget versus, different options that you could see throughout the year on that. It'll depend on the timing of any type of loan or deposit change. But again, as we said in there, we got a $100 million plus in bonds rolling-off. The FHLB, we're just using a short term catch all, and -- I think that rate at dollar amount will stay pretty consistent to decreasing a little bit throughout the year. And we just keep it on a short term basis. You guys have addressed most everything. I apologize if I missed this. But just curious, Cappy, I know you didn't buyback any shares during this quarter. We're more active early in the year, given kind of a lack of balance sheet growth, what – any more appetite or is it still kind of a wait and see approach there? Pretty much a wait and see, Brad. We have a metric we're looking at, and we'll get in the market if we think it's prudent. But we were not there during Q4, so we didn't have -- wouldn't have any shares. But like I said, we bought back, was it 250,000 shares, I believe for the year. So we keep our same metrics out there, but we'll just have a wait and see how to do. Got it. And then maybe sort of a bigger picture question for Ty. I knew last year your goal was to earn basically a $1 more in 2022 than you did in ‘21 and you guys did that, had a great year. I think everyone knows that ‘23 is going to be more challenging. Just kind of curious, what you would -- maybe not so much in net income dollars, but, kind of where do you want to see the bank 12 months from now. I know it's a pretty murky picture, but kind of, what would you classify as a successful year for the energy as it just sort of getting to the other side of this with a bigger capital base, a bigger reserve, just ready to take whatever e-comm approach that I just – just kind of curious if you could give us kind of a bigger picture outlook, maybe similar to what you did in ‘22? Yeah, Brad, I would say that, I mean, our main goal in ‘23 is to really have strong asset quality come through this cycle without any significant losses. We're going to be building reserves as we see it's prudent, have good earnings. We'll see what that actually turns into because like I said, there's headwinds across the board. But the other side of this, have stronger capital, stronger reserves and maintain strong asset quality to be positioned to go back on offense when things start going another direction, but it's going to be very much a defensive year for us at least. And I think probably a lot of banks as we're really trying to defend our core funding base, really defending asset quality, and trying to defend earnings and from just the different expense structures that have been under pressure the last couple of years and obviously fee income. So across the board, it's a year, it's going to be a year that our goal will be to, be in a better place than we are today, and that's saying a lot going through what could be an economic downturn in the storm. Thanks. Thanks for the follow-up. Just sticking with this bigger picture theme, Ty, I guess, the bank's been able to maintain this return on assets above 1% now for a number of years. You mentioned all the headwinds from lots of directions. Just curious about your expectations if you think you can continue to maintain this ROA north of 1% with all the headwinds out there? So, Matt, I don't think we would go below 1%, but now that being said, there's a lot of unknowns. And so depending on the reserves, we feel prudent that we need to put into our reserve account during the year. We'll obviously be looking at expenses very closely and we'll -- we're going to manage those aggressively. And the rest of it is just the market side of, from mortgage to SBA, different income departments. There's just not a lot of opportunity out there right now. So I don't see us dropping below 1% because we're going to be pulling our levers to avoid that, but I can't say it wouldn't happen either. Again, they're just – it's not the lack of clarity of – that we obviously had during COVID, but there is a lot of unknowns out there with everything going on until we see where the Fed's going to, land with rates and kind of how that, how hard or soft this landing is, we're just being pretty cautious in how we think about things going forward. I will say during COVID, we set aside $13 million in reserves and we didn't actually have any losses. So the fact that we set it reserves aside in ‘23 are just part of, as part of the CECL modeling and I can see a setting beside bit more reserves if we see further deterioration economy, whether that turns into actual credit loss or not will be our primary focus to see that doesn't. But so there's -- that's a that's a long way of saying I really don't know the answer to that question, but certainly that would be a goal that we would try to defend would be 1% ROA. Yeah. Thanks that commentary, Ty. And I kind of just following up on that around CECL and the allowance. You mentioned in 2020 kind of the big -- the big build there. I think you got the ACL ratio up to that, that 180% level in 2020. I know CECL is kind of always evolving, but just curious you think that's still is, is a 180 number still for the realm of possibility here this year? Or do you think you've -- this is a model that's kind of evolved over the last few years, which would make that less likely? I think it's less likely. I think the worldwide pandemic was a black swan event that deserved a lot of real conservative assumptions would -- where things were going. I think this is as dire as that. That being said, again, we're looking at a lot of unknowns from the economic standpoint. We keep coming back to the fact that we're proud, labor in Texas because Texas economy overall is strong. So I'm hopeful that on the other side of this, we fare better than most parts of the country, but this, there's just a lot of things, a lot of uncertainty out there that creates some uncertainty on our part. But I don't think it's near as dire's something that we were dealing with in 2020 with which was COVID and -- but we're just we're being cautious with how we look at it because there's a lot of unknowns. And again, the velocity of these rate increases and how the pads pull the liquidity out of the system and we're such, it's such scale, that's somewhat unprecedented, and that's the part that makes me a little cautious. Thank you for your questions, and I would like to remind everyone that the recording of this call will be available by 1 P.M. today on our Investor Relations page at gnty.com. Thank you for attending, and this concludes our call.
EarningCall_1432
All right. Good morning and welcome to JPMorgan’s 41st Annual Healthcare Conference here in San Francisco. My name is Harlan Sur. I’m the semiconductor analyst for the firm. And for the fourth time in 5 years, we have the team from NVIDIA presenting. And in fact, in the 41-year history of the healthcare conference, NVIDIA has been the only semiconductor company to present here. So, very honored to have them again here this year. For those of you that don’t know NVIDIA, leader in accelerated computing semiconductor systems, hardware and software platforms, in areas like artificial intelligence and deep learning, powering some of the world’s most powerful supercomputers and driving compute innovation for cloud and hyperscalers as well as large vertical markets like healthcare and life sciences. Here with us today is Kimberly Powell, Vice President of Healthcare at NVIDIA. She is responsible for the company’s worldwide healthcare business, including hardware and software platforms for accelerated computing, AI, visualization, the power of the ecosystems, of imaging, genomics, life sciences, drug discovery and healthcare analytics. So Kimberly, thank you for joining us today and let me go ahead and turn it over to you. Thank you, Harlan. Thank you very much. Good morning, everybody. Nice and dry. So an honor, really and I thank you, Harlan and JPMorgan, for inviting us back. This is absolutely a different kind of feeling year and I am excited to really share it with you. So, let’s just do the first housekeeping. Let me start with a reminder that the presentation in QA contains forward-looking statements and investors are encouraged to read our reports filed with the SEC and the information that relates to our risks and uncertainties facing our business. Super. So you might know NVIDIA as an amazing chip company. And in fact, we are, but we are much, much more than that. We are an accelerated computing platform company. Some scientists, some industries actually describe us as a time machine. We launched our GPUs into general-purpose programmable processors with our programming model called CUDA. We now have well over 33 million CUDA developers. And then for the last 15 years, we have been developing a full stack computing approach. So, the ability to program the chips, but also be able to introduce acceleration libraries, applications and purpose-built computing platforms, whether that’s large-scale data centers for artificial intelligence or embedded supercomputers for the medical devices industry. And so for each field of science and industry and applications, we create a full stack, everything from gaming to design, earth and life sciences and self-driving cars and robotics. And this allows us to really serve $100 trillion worth of industry. But we are here to talk about healthcare. So for healthcare, we created a platform called NVIDIA Clara. It’s after Clara Barton. She was the inventor of the American Red Cross, not after Santa Clara, where our headquarters is and it’s an AI computing platform for healthcare. We recognize that healthcare is becoming the absolute largest data-generating industry and we have global challenges increasing the cost of healthcare delivery and access to healthcare. So we build computing platforms to serve these grand challenges, leveraging world-class chips and systems. We build platforms that span embedded edge, all the way through to cloud applications and frameworks that span from healthcare delivery to disease and drug discovery. And I’ll hopefully show you some of that today. Our computing platform is why we adopted. We are relied on by all of the top medical imaging companies to turn sensor information into rich images. We are quickly becoming the de facto standard for surgical robotics platforms, for real-time sensor processing. We are helping the medical and cancer centers be able to be really data-driven in their clinical treatment decision-making. And we are increasing the accuracy and throughput of sequencing, so that we can reduce the overall cost of genomics and hopefully bring it more into the standard of care. And we are turbocharging the drug discovery process using artificial intelligence to really illuminate biological meaning and explore literally the infinite possibilities of small molecules and antibodies. So in healthcare delivery, imaging is the essential tool. It’s used at every stage of the patient journey, which is why it was one of the application areas we chose to focus on when I started at NVIDIA 15 years ago. As sensors evolve, so do the computing platforms and the applications in the healthcare delivery need to evolve. So from 2D sensors that allows us to do annual screening into advanced 3D and 4D to do quantitative image analysis and to capture things like function in the new Photon CT scanners that have recently been released. And now we are entering into what I call the fifth dimension where we can, in real time, with real-time sensing, we can – these devices can really actually take action. They can do things like self-navigate. They can do things like adapt while you are in the middle of a radiation treatment. So, very, very exciting times. And so much like the self-driving car industry, I love to use that parallel, because we can all sort of understand it, the healthcare industry is becoming software defined and is able to deliver great, great value through software. And in order to do so, you need two computing platforms. You need an AI development platform and AI deployment platform. And you need to connect these two so that the data that you were experiencing on the edge is very dynamic. And it’s that data that you can collect at the edge to bring back in to improve these applications and redeploy them. This is the as-the-service architecture and NVIDIA is building this end-to-end computing platform to serve it. So here is an example. NVIDIA Clara provides the imaging industry, radiology, pathology, all the surgical data, the AI development platform, it’s called MONAI. MONAI is an open source AI framework that we co-develop with the industry, the academic medical centers and experts. We open source it and then we have an AI deployment platform called Holoscan. So using MONAI as the AI framework for imaging, we have had over 800 million downloads of this framework. It’s absolutely accelerated. And it’s a driving force in the exponential growth in the AI research. You can see that through the publications here. And then to help close the gap between research and clinical deployment, we announced last year, NVIDIA Holoscan, is meant to be a commercial off-the-shelf more general purpose computing platform for these applications to live, so that not every medical device needs to reinvent their computing platform every time a new sensor technology comes to market. So a scalable real-time AI sensing platform and it can scale, as I said, from embedded to cloud. We have developer kits already out there in market and we announced design wins with several robotic surgery companies already. The innovators in the industry are using NVIDIA platform to deliver new applications across radiology into therapy. So as you can see, just as we described, Carestream uses artificial intelligence to really have a complete smart AI X-ray room. It’s at the room level all the way down to the device level to streamline workflows. You have Varian and Elekta where they can now use AI to do adaptive therapy, real-time adaptive therapy for their patients. I love the intuitive ion, because it allows you to navigate into the lung and biopsy areas, otherwise no humans could travel. So, these devices are absolutely opening up tremendous new capabilities and we are excited to see the medical device market continue to go through this revolution. But I want to go quickly next to a modality that is just super, super exciting. And I think we all saw a 2022 that changed the landscape of genomics tremendously. So genomics is a modality that is delivering great value to healthcare as well as research and drug discovery. It is the largest data generator in healthcare and growing rapidly. We are witnessing the continued decline in cost, enabling large-scale genomics programs to transpire. However, we need to be sensitive to the fact that a lot of times, when you advertise the cost of sequencing, it’s just the cost of sequencing and not the downstream analysis, which is ultimately the insights that we need to care for our patients and to deliver insights into discovery. And so this is why we are partnering across the genomics industry from new sequencers to bioinformatics platforms to cloud services and large pharma. So, 2022 was an absolute breakout year for NVIDIA accelerated genomics. We partnered with Oxford Nanopore and Stanford and many others to achieve a Guinness Record in clinical sequencing. We made NVIDIA Clara Parabricks free for research and partnered with the Broad Institute and put it in the Terra platform, so it’s – and it’s also available in every public cloud. And just this week, our partners at Bionano announced our work in accelerating 96 optical genome mapping workflows for high-throughput on-prem and cloud deployments, where they are having tremendous outcomes helping patients with this new structural variant capabilities. So, AI is becoming vital to all areas of genomics analysis, in fact. Primary analysis, which takes the signal or image and turns it into the genomic base calls, is all done now through artificial intelligence algorithms, because it helped realize a step function and accuracy as well as performance and the higher the throughput of the instrument, the lower the cost of sequencing. So, AI is also bringing that speed. And so just a few months ago, Seattle Children’s and the University of Washington were able to deliver a genetic risk assessment within 3 hours of a newborn’s life to rule out that a disease that their sibling had. By reducing the cost, increasing the speed and partnering with the clinical community, we can bring the commission to move sequencing more into the standard of care and we are really excited to do that across the board with all of our sequencing partners. With more sequencing platforms and modalities entering the market, we are going to be pushing these 40 exabytes of genomic data out there into the world. And we already have 500,000 genomes into 1 million genome databases associated with patient data. And these are becoming readily available. And so we must harness the latest breakthroughs in artificial intelligence to drive our biological understanding and therapeutic discovery. So, we had some incredibly exciting breakthroughs at the end of last year at the Supercomputing Conference. It’s a super neat example of how you can harness large genomic data to drive genomic understanding. And we worked with NVIDIA Argon National Labs, University of Chicago and achieved this just last – late last year and won the Gordon Bell Supercomputing Award. So you know the latest technology that is taking the world by storm is generative AI in large language models, most notably, Chat GPT. These models are trained on extremely large unlabeled datasets and they can learn context and meaning by tracking relationships and sequential data. Sounds very much like genomics, if you ask me. And so the same can be used on genomic sequencing data, and we did just that, co-developed a model called Genes LM. And it’s the first genomic scale and the largest biological language model to-date. So, used 110 million bacteria sequences from the Patrick database and then we fine-tuned it with 1.5 million SARS-CoV-2 genomes. And the model was able to not only predict the evolution of the virus, so potentially be useful for an early warning system, but it was also able to accurately identify variance of concern. And this is all published and the paper is in the source there. So, really, really super, super amazing breakthrough here. And I want to kind of give you a sense to what are these models learning and how are we going to be able to really understand how they learn and represent biologically relevant information? So let me just kind of play this video that the team made this to sort of give you a description of what’s going on. You could see through clustering that the model is finding semantic meaning in the latent space. And first, you can see it cluster genomes by their sequence length and then we are going to move into here how you can see it with its GC content indicating secondary structure stability and then we could even zoom in on particular enzymes and we can see the structural differences. And this is something actually the model was never trained for. And so, these models are actually helping us with interpretability. No longer are the days of deep learning black boxes. These foundation models give us a new ability and become the bedrock for us to really be able to read and start to understand biological meaning, so very, very exciting opportunities here. And this is – language models applied to genomics. We are just getting started. So like generative AI has set off broad use across all industries, AlphaFold set us the ImageNet moment for AM biology. And standing on the shoulders of giants and the breakthrough is coming from deep mine in open AI, biology labs at Meta, Roast Lab, Baker Lab, Barsele Lab and thousands more published papers in 2022. So, generative AI and biology is witnessing that same broad applicability across life sciences and drug discovery. Like I said from pandemic early warning systems to target discovery to protein structure prediction to virtual screening to drug target interactions and protein engineering, literally touching every phase of the drug discovery process. And so biology is going from an empirical science, experimentation and exploring the physical natural world to computer science and AI and we are – it’s quickly moving from a science to an engineering. So just this morning, we are announcing exciting results of a collaboration between NVIDIA InstaDeep, who congratulations, who just announced they were being acquired by BioNTech and Technical University Munich. And it’s resulted in a state-of-the-art genomics language model. Genomic language models are still in early investigation, DNA being one of the early notable ones. But you can imagine that much of this technology has been applied to natural language processing, but the genome has four letters in 3 billion – of 3 billion long sequence. So it presents new challenges. And so we use the NVIDIA Cambridge-1 supercomputer. We trained a collection of large language genomic models. And the highest performing model called nucleotide transformer. It achieves state-of-the-art on not only one of the benchmarks, but on 15 out of 18. And that means that this large foundation model is able to generalize across many, many tasks, which otherwise were built model at a time quite narrowly. The paper is really, really informative and it shows you that multi-species data was super important to be good at generalizing across these tasks. It was also very important in showing that you need larger and larger language model sizes. And that’s why NVIDIA is here, so we can enable that to happen. So, the highest performing model ranged from $500 million parameters to $2.5 billion and the $2.5 billion parameter model absolutely went out. So this will be published in a paper in the coming hours as archived chunks do it and then we will also make a fraction of these models readily available in the coming weeks. This is exactly why we created NVIDIA BioNeMo service, announced in September last year at our GPU Technology Conference, to enable the over $200 billion of R&D market and drug discovery. How can we give them access to the tools, the frameworks, the applications at data center scale to accelerate drug discovery? So BioNeMo is making it easier and more efficient to build and use generative AI in large language models across every stage of that drug discovery process I just enumerated. BioNeMo is in early access and we are working across the entire ecosystem with the leaders in biology and drug discovery field from research to the tech bios, all the way through to the large pharmaceutical companies. Today, we are also announcing with our partner, Evozyme, that we have built a generative AI model for protein engineering called ProT-VAE. It’s a protein transformer variational auto encoder. As you know, proteins are the building blocks of life. Every cell contains proteins. They are present in our everyday life from clothes we wear, food we eat, air we breathe. So the field of protein engineering looks to discover new proteins that can help design more effective drugs and remove carbon from the air or make more environmentally friendly close. However, the number of potential proteins far exceeds the number of particles in the universe. So Evozyme was able to use in a few short weeks, be able to use NVIDIA BioNeMo, use our pre-trained models, inject their special sauce with the VAE encoder and train a model and be able to, from sequence, generate proteins that they were able to experimentally synthesize and validate in the lab. The beauty about this is they use BioNeMo to fine-tune that model for family of proteins. So you can fine-tune it for a set of proteins that has the given properties function and characteristics that you want and then it can generate a library of those. And so I want to, again, give you a little flavor for what that looks like. So the – here’s an example of a protein called human PAH. It’s a protein responsible for a precursor to making pigments, hormones, also neurotransmitters, and it can even cause some pretty rare disease disorders. So the ProT-VAE model, it was trained on a PAH protein family. And here, we sampled two of the proteins generated and validated. The first protein generated had 51 mutations, which is about 85% similarity to the original, and it has a 2.5x, a huge 2.5x enhancement in function. This is what exactly you want when you’re developing new therapies. ProT-VAE also generated another protein with 167 mutations, so only 50% similar. This is where no human would intellectually go, but it was able to still achieve enhanced function. And so the protein language of ProT-VAE, it generated proteins nature’s never seen before, but it was able to maintain the function for the desired properties that they were measuring for. So this is the promise of these large language models, the ability to explore way outside the space. And so we’re going to extend what is today the common use of directed evolution and extend it into machine-guided directed evolution. And it’s really an accelerator to be able to discover new proteins. And so I’ll conclude with NVIDIA is building the compute platforms to address the breadth of healthcare to benefit from extraordinary capabilities enabled by generative AI and accelerated computing. MONAI for imaging, Parabricks for genomics, BioNeMo for drug discovery are helping the industry harness the computation and massive accelerate R&D and the workflows that drive healthcare and life sciences. And so the time for generative AI and biology is now. An explosion of seminal work happened in just the last 3 months of last year. I’ve exemplified them here with these models, and they are elucidating biological meeting. This is going to help us understand disease, and it will accelerate our ability to discover new therapies. And so we can build representations of large and complex data sets now and make meaningful predictions. So with that, I hope I leave you with a very bright and sunny future of what 2023 holds to really harness this technology, and I look forward to answering your questions. Thank you. Great presentation. Are there any questions out there? I’ll just ask, did you wait for the mic? Got one back there. NVIDIA’s revenues seem to have peaked in April of last year and have declined – quarterly declined since. Can you explain that? And why you think it’s temporary? Yes. Can you just talk about the competitive landscape, your customers? What other alternatives they have? How much has done internally? How much they need to go outside for AI solutions? Yes. I think the competitive landscape in artificial intelligence is we are in a new position at NVIDIA. We’re the only AI company that can also work with every other AI company. Our platform is well adopted in every single public cloud. It’s adopted by every single computer maker on the planet, and it ranges in sizes from embedded computers, all the way through to cloud platforms. And so if you look at that sort of future description of what we can offer the market, it’s a ubiquitous computing platform. And so it allows us to give the application developers, the industries the ability to transform business models and run these exciting new application workloads completely at scale. And as you know, we dedicated the company to artificial intelligence going back some 10 years ago – yes, at least 10 years ago. And the description language I described called CUDA has been around even longer, 15 years. And so the ability to reinvent sort of that software ecosystem is very, very tricky. And that’s why I really describe NVIDIA not as a chip company, but we are an accelerated data center company. And so to compete at that level is very, very difficult. And the software investment that we’ve made and our ecosystem partners have made is really what differentiates us and allows us to remain – allows us to innovate continuously at the speed of light, because we’re a full stack company. Questions? I’ve got a question. So – and maybe this will answer the gentlemen’s first question. Obviously, the consumer part of your business was weaker last year because of the weaker macroeconomic trends, some of the lockdowns in China. The data center business, which is where your franchise belongs, that’s – I think that grew 40%, 50% last year, and it’s still on - it’s still going at a very strong sort of double digits year-over-year clip. In fact, the data center business for NVIDIA has grown at a 70% CAGR over the past 3 years. It’s 60% of your total revenues. Underneath that, accelerated compute spending within healthcare continues to grow at an extremely rapid rate as you sort of reflected in your presentation. Can you just give us a sense, snapshot of the revenue scale, the growth rate for your healthcare franchise over the past few years? And how do you see the SAM opportunity for healthcare over the next 3 to 5 years? Yes. I mean healthcare is an extremely important industry, and it’s quite broad. And I hope I was able to let you know that we’re focused on some very important large markets within it, whether that be genomics, medical devices, the biopharma industry. So we believe that we could be the next $1 billion industry for NVIDIA. And you can – as I described, there is these two computing platforms that are needed for the future of how we’re going to innovate, develop software and as a service. And so one proxy you could use, Harlan, is look at the growth in AI research papers. It’s all being done on that development platform. So in the last 2 years, 120% growth. And then we’re addressing the ability to deploy these applications. they are maturing now. they are running in the data center. But now they also want to run at the edge because there is a lot of incredible value you can provide the industry when you’re developing real-time insights at the edge and then also have a flexible computing platform to continue that analysis and development back in the Data Center in the cloud. So that’s kind of the proxy that we use, and I think 120% growth sounds great. Hi. As a full – sorry, I lost my voice. As a follow-on from that perspective around this potentially becoming $1 billion industry for the Data Center sort of value proposition that NVIDIA can underpin, which of the traditional healthcare stakeholders need to enable or buy into the value chain of your end customers? So do you need reimbursement or regulatory or sort of government buy-in to the innovative products that get built on the stack for you to realize the $1 billion at your end? Yes. I think – I don’t know if that’s going to be our rate limiter at the moment. I think as I sort of alluded to, these large language models that we just described that were built in just the last 3 months of last year, they take an entire supercomputer to train them. So just to be able to explore this new capability in generative AI and large language models is a data center in itself for said customers. So the pharmaceutical industry, you can hear it all over the floor here at JPMorgan, they are building centers of excellence in AI. they are using all of the massive data sets that they have acquired over the last decades of drug development. There was $40 billion of investment that was pumped into what the term I love, which is tech-bios, technology-first biology companies, because they are – we’re able now to generate so much biological data to really drive this model development. So I think purely from that realm, we can reach that potential $1 billion opportunity amongst many of the other opportunities, but the analysis of genomics. But generative AI and large language models is just a clear easy one to understand. How much of your healthcare business today comes from genomics versus radiology and robotic surgery and more conventional health care segments? I don’t think we – I don’t know if I would be that granular about it. It used to be, call it, sort of like an 80-20 split where we would be so in the medical devices. I kind of grew what you described would be very medical device centric. That’s where we started. That’s where our heritage lies, going inside of CT scanners, inside the genomic sequencing instruments, powering the robotic surgery platform. So all of that was kind of, call it, 80%, and 20% was kind of coming from simulation that’s going on in the pharmaceutical industry, the genomic analysis. And we’re definitely now coming into more of a 50-50, because of some of the dynamics that I just described of massive amount of computing that is being – that is happening in pharmaceuticals. So the balance is there, but they are both growing at the sort of indicated pace of what you’re seeing in the AI research. And we buy a lot of your stuff as an AI startup, but I see that recently, the tech bio market has kind of declined. So some companies have, of course, grown dramatically, hopefully like us, but some have declined. So how do you see the split now between big pharma and tech bio going forward in terms of the GPU sales and also cloud sales? And because many pharmaceutical companies are still kind of in a little bit of an Intel world, but now, of course, everybody is switching to NVIDIA, but how do you see that split? Yes. I don’t want to predict the market, Alex. We’re kind of – as a platform company, we love to raise all boats and support the ecosystem the best way that we can. You’re a fantastic partner at – and Silico paved the way in showing that generative AI can be used across the complete drug discovery process coming to GTC for the last 10 years. So one, you have to be a believer. I think pharma is still trying to figure out, are we a believer in this technology? So they are doing a lot of dipping into it. And they are also kind of waiting and watching and partnering with the tech bio company. So I don’t want to make a prediction. I think the industry and the number of therapies and the personalization of medicine, there is room for everybody if they were up to me. But I don’t I think that there is a tremendous amount of promise. I think there is a need to think differently in this day and age with the tools that we have, with the automation of digital biology, that we need to see what the future holds. Thank you. I actually think that $1 billion is probably low balling it. I think that you are already at the billing That’s type. Thank you, Kimberly, for a great speak, that’s vibration for the future. So yes, so I’m Kim from WinFrame in Vietnam, and we trade – or we met on NVIDIA as a platform for training system as well as for production. So everything we moved from CPU onto GPU now. So I have two questions for you. One is, what do you think about ChatGPT that will be influenced into healthcare from your point of view? And second is the generated like sequential majority of that, what do you foresee about? Yes. Thank you, yes. ChatGPT is just – it’s an amazing technology, and it’s – you got to ask yourself, it’s just about what do you want to use it for? I kind of think about it right now, and just because in my own little world, back when we started work on AI and radiology, everybody jumped to the conclusion that AI and radiology has to diagnose somebody. No, it doesn’t. It has a massive amount of utility throughout the entire workflow and process of radiology. So it’s really about what do you want to do with the AI. Do you want it to write your assay? I want it to write my presentation? No, I did not. But I might want to do it to learn about how an enzyme. Or yes, you can ask some interesting questions like that. So I think it will. I think the type of technology will have and should have a utility in healthcare. I’m not saying that it does today, but I think it will. And its utility will be different than maybe where some people want to leap to. It doesn’t have to be that far of writing up a medical report and discharging a patient. And then for generative AI, I think there is been – Alex, who’s just here just already has proof points how you’re able to now discover novel targets and therapies that are in human trials. So that is well underway and being proven. And so if that isn’t promised enough, but then where you have this large body of biologists and scientists who may not come from the computer science world, what I love about generative AI in these language models is we can now interrogate them in an interpretable way. So we can now learn together that the computer science community and the science community can learn this together and really start to unlock biological meaning. We know we don’t know enough about the genome. So these models, my hope, is that they are going to help elucidate a lot of that. And then generative AI, like DALI, where you can go from one domain to another from text to an image, how could that not have massive utility in going through the different types of data sets in healthcare, from health records to genetic marker to what they saw in your image to what your pathology report is looking at? So with the likes of Genomics England and U.K. Biobank, we’re looking at, can we harness these new big data sets to see if there is a DALI in healthcare that has utility. So it’s not a panacea. It’s a utility. It’s a tool, right? And the whole point is can we accelerate? Can we increase our understanding and really move this field along and find more therapies for patients who need them? Thanks for the question. Questions? I’m going to put my semiconductor cap back on because your chips and your hardware systems are the foundational building blocks, right? And you guys unlock all the innovation via your vertical markets with the platforms. The team just rolled out its next-generation compute acceleration platform, the H100. That’s based on the Hopper architecture, 4-nanometer, leading-edge manufacturing technology, 80 billion transistors on a single piece of silicon, one of the largest chip designers in the world. Typically, the team focuses a lot of its efforts on cloud and hyperscalers at their early stages and followed by enterprise and vertical segments like healthcare. Talk to us about the adoption curve for the team’s prior generation A100 platform, and how do you see the uptake and momentum for the next-generation H100 that the team is rolling out now? Yes. I think it’s going to be incredible. So we’ve already started early access and early work in the area of genomics, as I said, right? There is an insatiable demand for compute to deal with the amount of data that’s coming off those instruments. And the more throughput, the lower the cost. So we already have a tremendous pickup in that. What I’ll say is, in the past, you had to wait for the technology to come up and become available. Well, we’re moving at speed of life. And throughout the first quarter of Q1, you’re going to see H100 popping up in all of the public clouds, tens of thousands of them. So we’re very excited that it’s going to be readily available. So these workloads can automatically take advantage of it. And with some of the incredible features that it presents from a perspective of these large language models, it has a transformer core in it for the transformer large language models, it has in it to really squeeze down the efficiency and take these large language models, which would either be very expensive to inference and be able to do that very effectively. So I think it’s going to be a rapid migration to H100, and the market is prepared and ready for it. Perfect. Well, we’re just about out of time. Kimberly, thank you for your participation and look forward to having the team back next year.
EarningCall_1433
Good morning. This is Jeff Siemon, Vice President of Investor Relations. Thank you for listening to General Mills' prepared remarks for our Fiscal 2023 Second Quarter Earnings. Later this morning we will hold a separate, live question-and-answer session on today's results, which you can hear via webcast on our Investor Relations website. Joining me for this morning's presentation are Jeff Harmening, our Chairman and CEO, and Kofi Bruce, our CFO. Before I hand things over to them, let me first touch on a few items. On our website, you will find our press release that posted this morning, along with a copy of the presentation and transcript of these remarks. Please note that today's remarks will include forward-looking statements that are based on management's current views and assumptions. The second slide in today's presentation lists several factors that could cause our future results to be different than our current estimates. Building on a good start to the year in Q1, we delivered strong results in our second quarter, including double-digit growth in organic net sales and adjusted diluted earnings per share. We also delivered a second consecutive quarter of gross margin expansion, representing continued progress toward restoring our pre-pandemic margin profile. The operating environment remains volatile. While we've seen some modest improvement in recent months, it is still far from pre-pandemic conditions, particularly at our up-stream suppliers. In this context, our team continues to execute well and we remain focused on advancing our Accelerate strategy and delivering on our fiscal 2023 priorities. Given our strong first-half results and positive momentum on our business, we are once again raising our full-year guidance for organic net sales, adjusted operating profit, and adjusted diluted EPS growth. Slide 5 summarizes our financial performance for the second quarter and the first half of fiscal '23. We drove 11% organic net sales growth in the quarter, fueled by strong net price realization in response to significant levels of input cost inflation. Adjusted operating profit was up 7% and adjusted diluted EPS was up 12%, each in constant currency. Our first-half results were also strong, with double-digit growth in organic net sales and adjusted diluted EPS. The operating environment in fiscal 2023 remains challenging and dynamic. On the cost side, we continue to forecast total input cost inflation of approximately 14% to 15% for the full year, including double-digit inflation in the second half. Volume elasticities continued to remain below historical levels in the first half, particularly in North America Retail. We are watching these trends closely, but we do not expect a return to pre-pandemic elasticity levels during fiscal 2023. We've seen some modest improvement in the supply chain environment in recent months, with logistics challenges continuing to ease and a slight reduction in the level of upstream supply disruptions. As a result, our customer service levels reached the high 80% range in U.S. retail by the end of the quarter, up from the mid-80s last quarter, though still well below our normal range of 98% to 99%. Despite these improvements, supply disruptions remain well above historical averages, and we aren't forecasting a return to pre-pandemic levels of supply disruptions or customer service during this fiscal year. Finally, we continue to see the pandemic impacting consumers' health and mobility around the globe. This has been most acute in China during the first half of this year. Overall, while it's encouraging to see some signs of supply chain improvement recently, we expect the pace of change in the operating environment to remain high for the foreseeable future. As we've said in the past, our job is not to predict the future better than our competition, but instead to be better able to adapt to change and deliver winning results regardless of the environment. That has been our recipe for success in recent years, and we're focusing on continuing that success in fiscal 2023 and beyond. We are continuing to drive our Accelerate strategy this year by executing on the three priorities outlined on Slide 7. We will continue to compete effectively by boldly building our brands, relentlessly innovating, and servicing the business with excellence. We will continue to invest for the future by delivering HMM and SRM to offset inflation, making strategic investments in the business, and continuing to progress against our ESG commitments. And we will continue to reshape our portfolio by ensuring smooth transitions for our announced transactions and assessing the landscape for additional growth- and value-enhancing acquisitions or divestitures. I'm pleased to say that we are making progress against each of these priorities through the first half. We're competing effectively once again in fiscal 2023, building on four consecutive years of strong market share performance. We are holding or gaining share in 37% of our priority businesses through the first half, but that includes a share decline in Cereal, where we're comparing against our unusually strong share gains in the U.S. a year ago when a key competitor was dealing with significant service challenges. On a two-year basis, our market share in Cereal is still up, and after adjusting for that change, we are holding or gaining share in 54% of our priority businesses, including a broad array of platforms in the U.S. and internationally. In addition to executing for today, we continue to make strategic investments to strengthen our brands and our competitive advantages for the future. Our Media investment was up double digits in Q2, and we expect it to be up double digits for the full year behind compelling campaigns that are increasingly leveraging our digital capabilities to reach consumers everywhere they interact with our brands. We've invested significantly in recent years to strengthen our capabilities that are critical to our future success, including Digital & Technology, Strategic Revenue Management, E-commerce, Global Impact, and others. Our total capability investments will be up again in Fiscal 2023, led by Digital & Technology. In fact, we've increased our investment in this area by more than $100 million dollars over the past few years, and we expect to grow in this area by double digits again this year. Additionally, we plan to increase our investment in growth capital by more than 50% in Fiscal '23. This includes investments to increase internal manufacturing capacity on key platforms where we see sustained growth into the future, such as pet food, Mexican food, hot snacks, fruit snacks, and cereal. Another important way we are investing for the future is through our commitment to Standing for Good. For decades, General Mills has taken action to reduce hunger and food insecurity in our communities through grants, corporate contributions, and food product donations. We work with food banks in more than 40 countries to expand food security and build long-term resilience for the future. One example is Feeding America. General Mills was a founding member of this U.S. hunger-relief organization more than 40 years ago. More recently, we supported the creation of Feeding America's MealConnect, a solution for the nation's charitable food system that allows member food banks to coordinate and receive donations from their local food businesses and grocers. As the only food-rescue technology available nationwide, MealConnect serves more than 12,000 nonprofits and has enabled the recovery of more than 3.5 billion nourishing meals since its launch in 2014. In addition to providing monetary support, General Mills helped co-create MealConnect's Logistics function, which works to reroute rejected or damaged but perfectly safe food products for donation at food banks. Standing for good is a critical pillar of our Accelerate strategy and is an important way we are investing for our future for our company, our planet, and for our communities. Switching gears, I'd like to spend a few minutes highlighting several businesses where we are consistently competing effectively and investing for the future, led by North America Retail. As we've shared in the past, we've built a multi-year success story in cereal behind strong innovation, renovation, and investment in what we believe are the best brands in the category. In fact, annual Nielsen-measured retail sales for our U.S. cereal business are up 20% since fiscal 2018 to more than $3 billion dollars. We've gained two-and-a-half share points over that time and solidified our number one position in the category. We're bringing more compelling news and innovation to the cereal category in fiscal 2023. Cheerios, which is by far the largest brand in the category, continues to keep its heart-health messaging fresh for consumers, while Cinnamon Toast Crunch, the second-largest brand in the category, is engaging new consumers with its crazy squares. In addition, we've launched three of the top five new products in the category so far in fiscal '23, and we are particularly excited about our second-half innovation plans. Our new Minis platform brings consumers miniature versions of their favorite cereal brands, providing a fun, new way to enjoy the big flavors they love. We've seen exceptional retail acceptance for these new products and they're already among the top turning items in their first few weeks on shelf. We've grown retail sales for our Pillsbury U.S. Refrigerated Dough business by nearly 50% over the past five years, to nearly $2 billion dollars, and we're working on our fifth consecutive year of market share gains after having added five points of share in the past four years. Pillsbury provides convenience and joy to families for special occasion and everyday meals. We're having another strong key baking season this year, and we're bringing the brand more regularly into consumers' everyday meal routines. Our most recent messaging with consumers highlights the many ways to conveniently make homemade using Pillsbury dough products outside the oven. And we are leveraging our data and connected commerce capabilities to personalize our messages. For example, by targeting our make homemade messaging to consumers who recently purchased an air fryer, we were able to drive lower cost-per-click and convert a higher share of our new Pillsbury consumers, further building confidence in the value of our first-party data. Our Fruit Snacks platform is an underappreciated local gem in our portfolio like Pillsbury dough, but on a smaller scale. Here, too, we've generated tremendous growth in recent years, with our retail sales in U.S. fruit snacks up nearly 70% since fiscal 2018 to more than $800 million dollars, and our market share up almost four-and-a-half points to 54% of the category. We accomplished these results despite being capacity constrained for much of that time, but we completed a $100-million-dollar capacity expansion on fruit snacks in Q1, which has allowed us to execute new channel expansion plans for e-commerce and convenience stores. Year-to-date, we've driven a 44% increase in our e-commerce retail sales on fruit snacks by optimizing our online shelf and consumer experience, leveraging our connected commerce capability. We've also expanded our fruit snacks presence in impulse channels, launching new peggable packaging that has helped us drive a 12-point increase in fruit snacks market share in convenience stores. With strong momentum, growing consumer demand, and plans for further capacity expansion ahead, we are excited about the continued runway for growth on fruit snacks. Another business that has a long runway of growth is Blue Buffalo pet food. The trends toward humanization and premiumization in the pet food category are strong and will continue to grow -- in the U.S. and around the world. We are focused on leading and expanding our presence in high-quality, natural feeding and treating for dogs and cats. We are led by our purpose to Love them Like Family, Feed them Like Family, which is the reason Blue Buffalo ranks as the number one brand pet parents are likely to recommend, the top brand pet parents will pay more for, and the most Loved and Trusted Natural Brand in the category. This has helped us drive terrific growth since we acquired the business in 2018, with our Pet net sales up by $1 billion through fiscal 2022. While we continue to believe in the long-run growth opportunity for our Pet business, we experienced an unexpected headwind in Q2 in the form of inventory reductions at some key retailers. As a result, while our all-channel retail sales grew at a high-single-digit rate in the quarter, our net sales were essentially flat. Beyond the unexpected retail inventory decline, our Pet results in Q2 largely reflected the continued impact of the capacity limitations and resulting customer service challenges that we called out on our first-quarter earnings call. Because of these service challenges, we pulled back on media and in-store support so as not to amplify our issues with on-shelf availability. While these headwinds have been felt across our Pet business, they've been particularly acute on our Dry Dog Food and Treats sub-segments. As we move into the second half of fiscal 2023, we expect to get back to double-digit net sales growth on Pet, supported by better customer service, stronger product news, increased brand support, and stable retail inventory levels. We expect our customer service will improve because of the external manufacturing capacity we've added on dry dog food and treats. To further improve service, we recently added a new distribution center and expanded capacity at our existing warehouses. We initially prioritized customer service improvement on Life Protection Formula, which makes up more than half of our dry dog food retail sales, and we've seen encouraging volume growth on that business in Nielsen-measured channels in the past six weeks. We're now expanding our service improvement focus to the rest of our Dry Dog portfolio and to Treats, leveraging our increased capacity. Improved customer service will also allow us to step up our media and in-store support, including a strong double-digit increase in media investment on Pet in the back half. And we have an exciting lineup of innovation and renovation launching across dog food, cat food, and treats. Our back-half news on Pet starts with significant renovation and innovation on our Wilderness dry dog food line. We're adding 20% more meat to our core Wilderness dry dog food products, and we're ramping up spending behind this news. We're also launching Wilderness Premier Blend, a new, super-premium offering that includes kibble, plus a new, proprietary tender meaty piece that dogs love in a convenient all-in-one solution pet parents will love too. On cat food, we're renovating our core dry portfolio and re-launching it under the Tastefuls equity. This launch builds on the success of the Tastefuls wet cat food line we introduced in 2021. Blue Tastefuls now offers a complete portfolio of feeding options for cats that provides the perfect combination of great taste and healthy ingredients. The new packaging is just starting to hit shelves now, and we'll support the news with media and in-store activations in the coming months. And on Treats, our added capacity will help us drive improved customer service on our Nudges, True Chews, and Top Chews products, which now carry the Blue Buffalo shield. With better on-shelf availability, we'll be able to turn on national media support and in-store merchandising, leveraging the Blue Buffalo master brand, which will help amplify awareness of these highly differentiated products. We remain bullish about the growth prospects for our Pet business. With a retailer inventory reduction and the worst of our capacity and service challenges behind us, and with exciting innovation and brand-building investment behind the strongest natural brand in the category, we're poised to continue Pet's track record of outstanding growth in fiscal 2023, and over the long term. Taking a step back, I continue to be pleased with how we're executing our Accelerate strategy to drive profitable growth on our core while continuing to reshape our portfolio. Thanks, Jeff, and hello everyone. Our second-quarter financial results are summarized on Slide 18. Note that there were a handful of events that impacted our year-over-year comparisons this quarter. These included the acquisition of TNT Crust, as well as the divestures of our European yogurt business, our international dough businesses, and the Helper and Suddenly Salad business in North America. We also had an impact from the international Haagen-Dazs ice cream recall that we announced last quarter. We do not expect any further material impact from the recall in the remainder of the year. Now let's move on to our Q2 results. Reported net sales of $5.2 billion dollars were up 4%, and organic net sales grew 11% in the quarter, reflecting continued positive price/mix in response to significant input cost inflation, partially offset by lower volume. Adjusted operating profit of $880 million dollars was up 7% in constant currency, with benefits from positive price/mix partially offset by higher input costs, lower volume, and higher SG&A expenses, including a double-digit increase in media investment. Adjusted diluted earnings per share totaled $1.10 in the quarter and were up 12% in constant currency. Slide 19 summarizes the components of our net sales growth in the quarter. Organic net sales were up 11%, reflecting 17 points of positive organic price/mix, partially offset by a 6% decline in organic pound volume. Foreign exchange reduced net sales by one point, and the net impact of acquisitions and divestitures was a five-point headwind to second-quarter net sales. Now let's turn to our segment results, beginning with North America Retail on Slide 20. NAR continues to perform exceptionally well, with our brands delivering for consumers and the business executing successfully amid ongoing volatility in the operating environment. Organic net sales grew 13% in the quarter, driven by positive price/mix, partially offset by lower volume. Despite elevated levels of inflation-driven pricing, elasticities continue to remain below historical benchmarks. Growth in NAR this quarter was broad based, with double-digit net sales growth in U.S. Snacks, U.S. Meals and Baking Solutions, and U.S. Morning Foods, and mid-single-digit net sales growth in Canada in constant currency. We continue to compete effectively, with 67% of our North America Retail priority businesses holding or growing share so far this fiscal year, when adjusting for Cereal on a two-year basis. Second-quarter constant-currency segment operating profit increased 24%, driven by positive price/mix and HMM cost savings, partially offset by high input cost inflation, lower volume, and higher SG&A expenses. Slide 21 summarizes our Pet segment results. As Jeff mentioned, Pet net sales in Q2 were negatively impacted by a reduction in retailer inventory. All-channel retail sales were up high-single digits in the quarter. We expect Pet net sales growth to accelerate in the second half behind increased capacity, improved customer service, strong innovation and renovation news, and increased brand-building investment. Additionally, we expect retailer inventory levels to remain stable in the back half of the year. On the bottom line, second-quarter segment operating profit totaled $87 million dollars compared to $132 million a year ago, driven primarily by high-teens input cost inflation, a significant increase in costs related to capacity expansion and supply chain disruptions, and lower volume, including the impact of the retailer inventory reduction. These headwinds were partially offset by positive price/mix. We expect to deliver profit growth on Pet in the back half with stronger volume performance, less headwind from capacity and supply disruption costs, and better alignment between price/mix and inflation. Moving on to our North America Foodservice segment results on Slide 22, organic net sales grew 17% in the quarter. As we expected, this quarter's performance included greater price/mix benefit on our non-flour business compared to Q1, and less benefit from market index pricing on bakery flour, which is dollar profit neutral. Segment operating profit for the quarter was up 20%, driven by positive price/mix, partially offset by higher input costs and higher SG&A expenses. Second-quarter International segment results are summarized on Slide 23. Organic net sales were up 5% this quarter, driven by good growth in Brazil, our Distributor markets, and Europe & Australia, partially offset by a decline in China due to continued consumer mobility restrictions due to zero COVID policy as well as the impact of the international ice cream recall. Second-quarter segment operating profit totaled $18 million dollars compared to $59 million a year ago, driven by higher input costs and lower volume, including the impact of divestitures and the ice cream recall, partially offset by positive price/mix and lower SG&A expenses. With comparisons against the Yogurt divestiture and the Ice Cream recall now behind us, we expect to generate profit growth in International in the back half of fiscal 23. Slide 24 summarizes our joint venture results in the second quarter. Cereal Partners Worldwide net sales were up 2% in constant currency, driven by favorable price/mix, partially offset by lower volume. Haagen-Dazs Japan net sales were down 10% in constant currency as the business lapped strong new product performance last year. Second-quarter combined after-tax earnings from joint ventures totaled $25 million dollars compared to $33 million dollars a year ago, primarily driven by unfavorable foreign currency exchange as well as lower constant-currency profit at Haagen-Dazs Japan, partially offset by favorable CPW price/mix. Turning to total company margin results on Slide 25, our second-quarter adjusted gross margin increased 100 basis points versus last year to 33.2%, driven by positive price/mix and HMM cost savings, partially offset by mid-teens input cost inflation, higher other cost of goods sold, and supply chain deleverage. While this is our second quarter of gross margin improvement, our adjusted gross margin is still below pre-pandemic levels, and we have more work to do to restore our historical margin profile. Adjusted operating profit margin increased 60 basis points in the quarter to 16.9%, driven by higher adjusted gross margin, partially offset by higher SG&A expenses. Slide 26 summarizes other noteworthy Q2 income statement items. Adjusted unallocated corporate expenses increased $30 million dollars in the quarter, primarily reflecting increased capability investments this year and certain discrete favorable items a year ago. Net interest expense decreased $1 million dollars, driven by lower average long-term debt balances, partially offset by higher rates. The adjusted effective tax rate for the quarter was 21.1% compared to 22.3% a year ago, driven by certain discrete tax benefits this year. And average diluted shares outstanding in the quarter were down 2% to 602 million, reflecting our net share repurchase activity. Our first-half fiscal 23 results are summarized on Slide 27. Net sales of $9.9 billion dollars were up 4%, including a five-point headwind from net divestiture and acquisition activity and one point of unfavorable foreign currency exchange. Organic net sales increased 11%, driven by positive organic price/mix, partially offset by lower organic pound volume. Year-to-date adjusted operating profit of $1.8 billion dollars increased 8% in constant currency. And adjusted diluted earnings per share of $2.21 were up 13% in constant currency. Turning to the balance sheet and cash flow on Slide 28. While we drove strong growth in adjusted net earnings in the first half, our operating cash flow was down from $1.5 billion dollars a year ago to $1.2 billion in the first half of fiscal '23, driven primarily by an increase in inventory and higher cash tax payments. Year-to-date capital investments in the quarter totaled $227 million dollars. We remain on track for capital investment to total roughly 4% of net sales for the full year. And we returned $1.4 billion dollars in cash to shareholders in the first six months of the year through dividends and net share repurchases. On Slide 29, you can see our increased guidance for fiscal 2023. We now expect organic net sales to increase 8% to 9%, reflecting better volume performance and improved price/mix relative to our prior outlook. We continue to expect elasticities will remain below historical levels over the remainder of this fiscal year. We now expect adjusted operating profit to increase 3% to 5% in constant currency, reflecting stronger top line performance. We continue to expect total input cost inflation of 14% to 15% of total cost of goods sold, HMM cost savings of 3% to 4% of COGS, moderately lower supply chain disruptions versus last year, and increased investment in brand building and other growth-driving activities. Constant-currency adjusted diluted earnings per share are now expected to increase 4% to 6%. This updated outlook reflects stronger profit growth and higher net interest expense, which is now expected to total more than $400 million dollars for the full year, reflecting rising interest rates. Our guidance for both adjusted operating profit and adjusted diluted EPS both include a three-point net headwind from divestitures and acquisitions and an estimated one-point headwind from the ice cream recall. Finally, we continue to expect free cash flow conversion will be at least 90% of adjusted after-tax earnings. Thanks, Kofi. Let me close with a few thoughts. I continue to be pleased with how we're executing our Accelerate strategy and driving profitable growth, including delivering strong results again in Q2. We're competing effectively, building on four consecutive years of positive market share performance, and we continue to invest for the future. While we have work to do to overcome some short-term headwinds in Pet and International, we've taken actions to drive stronger results in those segments in the second half of this year. I'm also pleased that we are once again raising our guidance for the full year, building on our strong first-half results and compelling plans for the back half. Thank you for your time this morning. This concludes our prepared remarks. I invite you to listen to our live question-and-answer webcast, which will begin at 8:00 a.m. Central time this morning and will be available for replay on our Investor Relations page at GeneralMills.com. Greetings, and welcome to the General Mills' second quarter fiscal 2023 earnings Q&A webcast. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded, Tuesday, December 20, 2022. Thank you, Kelly, and good morning, everyone. Thanks for joining us today for the Q&A session on our Q2 fiscal '23 results. I hope you all had the time to review the press release, listen to our prepared remarks and view the presentation materials, which are made available this morning on our IR website. Please do note that in our Q&A session, we may make forward-looking statements that are based on our current views and assumptions. Please refer to this morning's press release for factors that could impact forward-looking statements and for reconciliations of non-GAAP information, which will be discussed on today's call. I'm here with Jeff Harmening, our Chairman and CEO; Kofi Bruce, our CFO; and Jon Nudi, Group President of our North America Retail segment. Let's get to the first question, Kelly. So please get us started. Thanks. I think just to kick it off, I guess, I appreciate that capacity constraints can often lead to a gap between shipments and retail takeaway, but obviously, the differential in Pet was far greater than anticipated. So, I'm trying to get a sense of why would retailers pull back on orders when capacity is constrained and demand remains so strong and does this pose any risk ultimately to the demand side of the equation? And then I've just got a quick follow-up. Yes. Sure, Andrew. Thanks for the question. I would say, ironically, in the second quarter, a lot of what occurred in we anticipated, including retail sales and the fact that we were capacity constrained. And as we look ahead, we guided to double-digit growth for the second half of the year, by which I mean starting in Q3, given the strong level of innovation we have and the fact capacity is online, and we've got really good advertising and marketing support. The one thing that was different than we expected was a drawdown in retail inventory you pointed out to. But we don't -- first of all, most importantly, we don't think that this is a long-term trend. We think it is something to happen this quarter. In terms of the rationale why, I would say, in general, the retailers have carried a little bit less inventory across the board during this time only because with inflation, what you don't want to do is carry a lot of working capital. And so -- but certainly not eight points worth of differential. The other reason I would say is that because we lack capacity, there are a lot of categories like treats, for example, where normally we would merchandise a lot during this time of year, but we couldn't do that. And so not only do we not -- were we not able to service demand, but we had to pull back on merchandising. And a lot of times, retailers carry more inventory when they're going to merchandise. And so you really see that in our treats business. And then the third reason is we had a couple of big retail customers and we have a more mass merch orientation that didn't take inventory coming into the season because that warehouses full of other things. It's a little bit different customer set than our North America Retail business, for example. And so that's why we don't see it on the North America retail side. So, those are really the laundry list, if you will, of reasons why inventory was less. But as you can imagine, we've done a very deep dive on inventory levels by customers. And I can tell you, we don't think there's going to be a repeat performance of that nature in the third quarter. In fact, that's why we're comfortable guiding up double-digit sales growth again. And then, I think you were looking for flattish gross margins or so for the full year, if we were thinking about last quarter's conference call, obviously, with the upside to gross margins in this quarter despite the pet constraints on profitability. Could we see gross margins likely up year-over-year for the full year at this stage? Sure. Andrew, it is Kofi. Thanks for the question. Certainly, as we look at our revised guidance, that's within the range of possibilities. And while we're not giving specific guidance on gross margin, we're very comfortable we're making good progress against our long-term goal of getting our margin back to pre-pandemic levels. We're still about 150 basis points back of there. So, we're going to continue to drive at the things that will help us improve the margin profile as we go forward. I wanted to just ask, you seem confident understandably why, why the de-load won't happen again, and thank you for the clear explanation, Jeff, on what the drivers were. I'm just curious, as you progress into your third quarter, it might be a little early to ask because we're still not at Christmas. But are you seeing any refilling of inventory levels by retailers, if you addressed this already, forgive me, but just trying to get a sense of sort of more real-time data as to what's going on? Yes. I think a couple of points, Ken. Yes, we are early in the quarter. Having said that, there are a couple of things that give us confidence in our forecast for the third quarter, the first I would start with Life Protection Formula, which is our biggest dry business. And we've seen over the last six weeks, we've seen demand really rebound quickly. And that's important because that's the first business that we could bring back up to appropriate service levels. And so that gives us confidence. In addition to that, we -- I did tell you we were going to grow double digits in the third quarter. And I can report that we're only about three weeks into December. So it's -- but three weeks is not nothing, and I can tell you, we're on track to deliver what we said we're going to do in the third quarter, which again gives us more confidence that we're going to be able to do what we say we're going to do and that we've seen the pipeline of inventory start to refill itself because we're able to service the business better, and it's especially true on treats. And Ken, I'd add just to put some numbers on it, this is Jeff Siemon. For Life Protection Formula, the movement in Nielsen measured channels in the last month is up almost 20% and volume has been positive and accelerating recently now that we've gotten service back in the 90s. So just to put some dimensions on it, it's been encouraging to see that business grow basically in line with or even ahead of where the category is growing overall. And then a quick follow-up. Just how do we think about the impact of adding more production from co-manufacturers and maybe re-stepping on the marketing pedal, for your pet food business in the third and fourth quarters, obviously, hopefully, there will be a better volume turnaround, and that will help as well. I'm just trying to get a general sense of, I guess, how to model those margins given all the puts and takes. So let me start and then Kofi can give you some more thoughts on the margin. I would say how to think about the whole basket. I would say, clearly, we anticipate our reported net sales to improve to double digits in the second half of the year behind all of the activity we talked about. Given that we went -- we've gone externally both in treats and more importantly, in dry dog food for -- to get capacity sooner, that obviously helps our service levels, external capacity doesn't tend to be as profitable. So I wouldn't anticipate our gross margins to rise as proportionately as our sales would rise. But the benefit is that we're getting back, and we're satisfying pet parents sooner. The other thing I would say is that to the extent that we increase advertising in the third quarter, and I think we have some really nice advertising. We're going to increase that double digits in the third quarter. I wouldn't expect our operating profit margin to rise as fast it should get better, a lot better, but it probably won't rise as fast as the sales growth in the near term, but that's a choice that we're making. And our choice is to get back to growth first and making sure we can get that flywheel going again. So Kofi, you want to add any color to that? Yes. And that said, we do expect profit growth on our pet business in the back half of fiscal '23. Some of the key things you'll see is we'll expect price/mix to catch up with inflation. We've got another effectively round of pricing coming through at the beginning of calendar year '23. We don't expect the pressure on supply chain to be as acute. So, we won't see as much sort of drag from other cost of goods sold. And of course, we're not expecting the inventory depletion and the pressure that and deleverage that comes with that headwind. So as a result, we would expect our second half top line growth should give us still a solid profit growth even if it's slightly behind the top line growth. Thanks for the question, and happy holidays. And going -- sticking with pet, you just mentioned another round of pricing you expect to come online in CY '23, I believe, and there's a narrative that the pet food industry in the U.S. could be on the horizon of getting more competitive due to potential supply/demand imbalances. I'm wondering, if you can provide any color on what you're seeing on that front? Yes, Max, thanks for the question. As we -- when you say more competitive, first of all, I would say that category is always competitive. There are a lot of great competitors in the category. Having said that, I suppose the question comes down to, you're talking about price competitive or something like that. What I would say is that we continue to see the premium end of the category growth. And we see Blue Buffalo is present life protection formula, again, continue to accelerate once we get supply back online. And in general, we see the premium part of the category doing quite well. And it's a category that really lends itself is a fairly inelastic category. And that's because pet parents really, really care about what they feed their pets. And so I don't anticipate between the nature of the category and the fact that we're still seeing inflation. Our inflation for the Company in the back half of the year will be up double digits. And so, it's not as if we're answering into a deflationary environment. We're all still making -- we're all still kind of recovering service levels. So the supply chain, we're not in an overcapacity situation. Supply chains are still have some catching up to do. So because we see inflation, because of the nature of the consumer, because of the nature of the supply chain, even though it's always a competitive category, I wouldn't see it getting more competitive in terms of pricing in the near term only because of all of those factors. Great. And one follow-up. So you mentioned that you expect the price elasticities to remain below historical levels during the remainder of FY '23 and also that there particularly benign in North America retail. I'm wondering what you're seeing on this front in your international businesses, particularly European Cereal as we've heard some commentary of a return to normal levels of elasticities in those markets from other industry participants. Yes. I guess I would say, in general, not commenting on cereal specifically, I guess, but in general in Europe. First of all, we say the economic situation in Europe is more challenging than it is here, particularly driven by energy prices and unemployment, that's a little bit higher than it is in the U.S. So I would start with that. The second, I would say, is that elasticities in Europe tend to be a little bit higher than they are in the U.S. normally, and we're seeing that in this environment as well. And that kind of plays itself out across categories. And so, whether it's cereal or bars or ice cream, so we -- so I would say the situation in Europe is a little more challenging than it is here, but it really has to do with a combination of macroeconomic backdrop, combined with elasticities in general, tend to be a little higher. But I would say directionally, we're seeing the same kinds of things there that we see here. You mentioned some new pricing actions in pet. Do you expect to take more pricing actions in North America retail as well? The public comments from the grocers sound increasingly concerned about higher pricing and the impact on their consumers. So, I wanted to know if there's any blowback on that. And then also, in the past, there's been unusual de-loading in January by some retailers to protect balance sheets. I think you mentioned it here today. Do you see any risk of that happening as well? So Rob, I would say as it relates to pricing, I mean, we've announced some pricing on pet. We've announced that to our retail customers already to take effect, I think, February 1. So we've announced that already. In terms of -- but I will also remind you that when we started the year, we said that for most of this fiscal year, we've taken most of the pricing that we need to take in the market already for this fiscal year. So that also remains true. But I will also say in the back half of the year, we're expecting double-digit inflation. So it's not as -- it may decelerate from where it is now, but then decelerating to double digits is not exactly zero. And even as we look across a longer horizon, I don't want to play Nostradamus with inflation rates. What I will say, though, is even looking out past six months, it's pretty clear to us that we'll still see an inflationary environment. It may or may not be as robust as it is now, but it will still be an inflationary environment, driven quite a bit by wage increases. So it's hard for us to see an environment where we don't see inflation. Even if that inflation -- those inflationary levels may not be exactly what we've experienced over the last six months. And so as we look at our business, we'll continue to look at pricing. But the key is that the pricing has to be justified. And this has always been the case. But it has to be justified based on the cost that we're seeing. And we find with our retail customers if we can justify the cost that we're seeing and that they know that we're investing in the growth of our categories, which we are through double-digit consumer spending increases, launches like minis and cereal and like the innovation we have in Pillsbury and Blue Buffalo, then the conversations are a lot more productive than otherwise. So that's, I guess, what it was a long-winded answer to a fairly straightforward question on pricing. With regard to retailer inventories, I would say we have seen a little bit less retail inventory because of this inflationary environment. But I would say as we look forward, we've probably seen -- I wouldn't -- I don't think that's a risk to our go forward either on Blue Buffalo or our business in general. So that's kind of some generalities. No, I think you hit it. I would just say that our SRM capability is something I'd point to is much more sophisticated than it was a few years ago. So as inflation continues to come, we'll leverage the entire toolbox. So it's not just list pricing, it's promotional optimization and mix and pack price architecture. And by leveraging all those tools, we believe that we'll be able to combat inflation as we move forward as well. And in terms of retailers, as Jeff mentioned, I mean, is pricing has never been easy. And even over the last couple of years that we've seen significant inflation. But if we can bring in a strong market basket story, we have had success moving pricing through the market. Can I ask a follow-up? In the past, have you been able to go to retailers and show labor inflation internally and use that as a rationale for raising price. It seems like that's something new. Yes, Rob, I think the scale of the inflation is different today, right? So we're seeing a double-digit inflation. And historically, over the last decade or so, we haven't seen a lot of inflation has been low single digits. So it really hasn't been a conversation because there really hasn't been enough inflation to take significant action. I think with the scale of the inflation we're seeing today and the sophistication, as I mentioned as well, we're able to really break down where we're seeing inflation and some things are starting to moderate. But at the same time, you're seeing things like labor, certainly, sprout remains sticky, and it's in the equation. And we've gotten more sophisticated but our retailers have as well. So again, I think we have really good constructive conversations that are really based on facts at this point. Rob, or where we see that impacting us is not so much our own labor, but it's the labor at our suppliers, which translates through their pricing to us. So yes, there's labor inflation in our own facilities, et cetera, but the much bigger aspect of labor is upstream at the supplier base. I just wanted to come back to the elasticities and maybe understand a couple of things better. You say you don't expect to sort of revert to more normal levels over the second half. I guess -- or at least over the year? And is that just because half the year is done? Or what are you seeing something different maybe structurally what -- what's driving that expectation? And what would you consider a more normal level to be? I think what drives our assumption, Michael and [Frank] look is an assumption is that we still see the conditions for an elasticity relative in elasticity, not complete inelasticity, but relative inelasticity in the marketplace. And those conditions are a continuation of inflation. And even if they're not what we experienced in the first half, they're still double digit. The second is supply chain, the supply chain still having supply chain disruptions. Again, our service level is in the high 80s. So that's certainly a lot better than they were a year ago, which were they were in the 70s, but it's certainly not at 98% either. So a continuation of supply chain challenges. And also, consumers to be under pressure. In fact, it's highly possible consumers will be under more pressure over the next six months. And when that happens, consumers tend to eat at home more rather than eat out more. And so, it's very possible we'll see -- continue to see trading into food eaten at home. So those are the factors that we see and drive our assumptions that there won't be a significant change in elasticities over the next six months. But look, those are the assumptions based on what we see right now. Okay. Great. That's helpful. And I know China is fairly small, but just would love to get an update on maybe what you're seeing there. Obviously, in the second quarter, there were some of the lockdown, I guess, pressure or the -- certainly, food service challenges from those restrictions. As kind of evolving there, any update on the latest of what you're seeing in China and how we should think about that? Well, there's been a fairly significant policy change by the Chinese government on COVID and zero COVID. And it's going to be a ride, I think, for the next few months because we've had a population that's gone from relatively no COVID to quite a bit of COVID in the marketplace. And so that now people don't lock down as much. But I think when you have as much COVID as they have, we'll see not as many people venturing out, which is very good for our Wanchai Ferry dumpling business, which is half of our business and not as good for our Haagen-Dazs business. And so, I want to think about that business over the next few months, I think it's going to be a wild ride. But I would think that our dumpling business will do quite well. And our Haagen-Dazs business will maybe be a little bit more challenging over the next few months, but they're about equal in size. Since they pivoted on policy, they've conveniently stopped giving information on case counts. But so I guess, yes, it -- is it pretty chaotic there? I mean, I guess we're just in for a few months of some uncertainty, but it sounds like you're positioned while neither stated that pretty well. I think so. I think in the grand scheme, it won't be material for General Mills, the shift from one to another. It may be a little more material for our Chinese market, but it won't be for the Company in aggregate. In terms of the case counts, I don't know, but they're clearly going up, and they're going up, they're going up rapidly for the moment. I wanted to come back to the Pet segment. And just to revisit what gives you confidence that you can return to double-digit growth in pet in the second half of the year? And can you decompose how you're thinking about the drivers of that growth? I mean, can you grow volumes with the capacity that you've secured? Or do you expect volumes to continue to decline with the growth driven predominantly by the pricing? So the -- so Pam, what gives me confidence are a combination of factors. And I think the key -- the first key factor is the restoration of our supply chain and of our capacity. And this particularly important in our treats area, and -- but it's also important for dry dog food and cat food as well. But I would start with treats and then go to dry dog and cat food. So the first piece of confidence is that we've -- we have gained enough capacity to actually to be able to grow volumes in the second half of the year on both of those platforms. And so that's the first piece. The second, though, then it has to be backed up by good marketing. I feel really good about our innovation, really good about what we're doing on the Wilderness brand, I feel good about our change to Tastefuls and cat dry food. I feel very good about our partnerships with our retail customers to get our treats business take started again. We have great products on treats. We've rebranded a lot of what we had bought from Tyson to Blue Buffalo. And so the branding is really good. We've got good programs with our retail customers. So I feel good about our ability to drive our treats business. And then we're going to increase our brand building by double digits. And we've actually already seen a return to volume growth on Life Protection Formula, and we didn't have innovation on that. We didn't have advertising increases on that. All we had a supply. So I feel like the key is supply and then building on top of that really good innovation, strong in-store execution on treats and good advertising at good levels on top of that, that gives me quite a bit of confidence that we'll be able to turn around the Blue Buffalo business in short order. And as we've seen through this whole time, even though our second quarter was not what we wanted and not what you all expected, the brand remains really good. And we've done a lot of brand -- a lot of brand testing. The brand remains really good. The trends towards humanization are really good. So the tailwinds in the category are still there for us behind a good brand and increased supply and marketing. That's helpful. And you pointed to a lot of innovation that's coming within the Pet segment. Is there anything in particular that prompted your plans to step up innovation or were these initiatives already in the works? And how should we think about the margin impact of the innovation? You mentioned you're adding more meat to Wilderness. How are you planning to offset these costs? And what is the margin profile versus the existing portfolio? Well, I would say on the innovation front, we've been we've had innovation that we've been willing to put in the marketplace for some time. But obviously, we haven't been able to supply the base business where one or two. So adding innovation on top of that is probably not a good idea. In fact, I think the people listening should take a sign of confidence that we can supply our business better because we're bringing this innovation to the market -- marketplace. And we certainly wouldn't do that if we didn't think we could supply it. That would be my fit point of innovation. So we've had this plan for a while. When it comes to the product renovations themselves, I mean, Wilderness is a high-priced, high-margin business. And so, to the extent that the pet parents want more meat in the product, which they do, and we're giving that to them, that's to do wonders for our margin profile. In fact, I would tell you the most important thing that we can do to enhance our margins in pet is to grow pounds. And so, to the extent that we have the supply and the news on a high price, high-margin brand, that should be just what the doctor ordered for the margins for the pet business. Good morning. I want to start first, if I could, with a question on the gross margin, perhaps for Kofi, but just to understand, the sequential change in the gross margin from 1Q. And again, your gross margin was up nicely year-over-year, and that's been quite unique in the industry. I just want to get a sense of any factors that are worth considering that occurred sequentially. And obviously, the one that stands out, I think, would be around Pet. Was that one of the sequential drivers of the softer gross margin absolute performance or any other factors that are worth noting there, if you could, please? Sure, Chris. You have the plot. Certainly, Pet is a contributing factor, but there are also some other structural things around mix of our business as we move from Q1 to Q2. We have a lot more volume from businesses such as soup and baking products, which is, as you know, are heavily merchandised in that seasonal window, so those tend to drive us to a structural step-down in margin as we move from Q1 to Q2. And the other factor, as you rightfully noted, was the acute pressure on Pet margins in this quarter. Okay. And I just had one more follow-up on the Pet profit. And you had indicated that the second quarter would be a little softer. You had some costs related to getting third parties and co-manufacturing ready, some inventory and warehousing costs. I guess I just want to get a sense of this second quarter Pet profit performance was unique. You plan on some of that occurring. So are a lot of those costs then sort of embedded in the business? Do you have any ongoing costs related to the co-manufacturing outside just that's a lower margin way to supply your business? Sure. So I would expect some of those costs to be structural for sure as we go forward. We'll have external supply chain costs related to the step-up in volume that we're getting. But not all of those costs will carry forward. Some of these costs were related to disruption and enrollment of additional warehousing capacity in that window. So we would expect in aggregate that the drag from those costs will reduce as we step into Q3 and Q4 for this year, which is part of the reason why we also expect profit growth and profit margin improvement as we step into those quarters. Just another angle on that gross margin question. If we look at this quarter, your gross margin is still down maybe 80, 100 basis points from pre-COVID levels, tons of cross currents there, but I'm wondering how you're thinking about that gap and your ability to get back to pre-COVID levels on gross margin? And the things I'm thinking about are you mentioned the supply chain friction costs, but there's going to be maybe be some categories out there where you're going to be pricing to protect profit dollars. And so, there's some math going against you. So I'm wondering if you'll need to see some easing in some key commodities in certain categories. But the other thing I'm also thinking about is you've had some very strong growth in some of your highest margin categories. So, I could imagine a scenario that you'd be -- particularly as you're doing as well as you're doing with dough that you could be above past peak as you get past some of these friction costs. So any commentary there would be helpful. Sure, sure. I'll try to do justice to your question. So as you think about the path forward, obviously, you hit on the first thing and sort of one of the precedent conditions will be a return to something that is a much more stable and closer to historical level of supply chain disruptions. We're still probably running about 2x our historic levels well off of the peak of 6x to 7x where we were last year, but still enough to be meaningful and significant. And we would also expect that once we get out of a short supply environment, it will be easier to get at HMM and more fully utilize that lever. And that we would expect some of the pandemic era costs related to servicing the business in a more stable environment will become easier and lower. So structurally, we view our job to kind of claw back about 150 basis points of margin versus our sort of pre-pandemic level. I think the stable environment from a supply chain standpoint will be one of the first and the most important things. And then second, it will be probably a return to more historic levels of inflation, moderation of inflation, which -- who knows when that's coming. But we're certainly positioning our business to make sure that we're taking the cost out as we as we have the opportunity to do so. And just a separate follow-up. You talked about investments in your prepared remarks in digital and other capabilities. Could you just give us a sense about what you think the benefits will be from those investments and when and where we'll see that? Sure. So a lot of the focus of our investments in digital and technology to enable our marketing activity and as well our supply chain efficiency. So, we'll see benefits both in gross margins, and we would expect to see that deliver on growth. And then, I'll ask Jon if he wants to weigh in since we're seeing a lot of investment in our North America retail business. Yes, absolutely. So as Kofi mentioned, supply chain is a big focus and there's a lot of opportunity for efficiency there. Now on the marketing side is really something we call connected commerce, and it's really the funnel -- the top of the funnel is we generate demand and in a digital world, more and more of our marketing is becoming digital marketing, performance-based marketing. So, we've invested heavily to acquire first-party data and really make sure that we have a strong marketing engagement platform that we can then serve up relevant messaging at scale and really customized for our consumers, we're seeing really incredible returns from that. Further down the funnel, at the bottom was actually the transaction that we're kind of ambivalent whether it's in-store or online. The margins are the same. We actually over-index from a share standpoint online. But we've developed quite a few digital tools to really understand the digital shelf. We grew up in a world that a bricks-and-mortar world that we understand Nielsen and the drivers of our business, digital is different, right? So, we had to develop the dashboards for our team is to really look at the metrics that matter, make sure the digital shelf is correct, make sure that our search metrics where they needed to be. And a lot of that is now digitized. It's on our leaders, computers every day in a dashboard form, and they're making real-time adjustments to the business. So I think you're seeing it actually translate into strong performance in the market today, and will continue to become even more sophisticated as we move forward and continue to invest in this capability. Can you just clarify or quantify how much the retailer inventory reduction was in Pet this quarter? And then also, I apologize if I missed it, which channels or retailers was the inventory reduction in? I'll answer the first part of that question for you. The second one, I'll take a polite pass. But the -- on the first part, our retail sales, Cody, were about -- up about 8% during the quarter, and our reported net sales were flat. And so the difference between that 8% points was a reduction in retailer inventory for the variety of reasons that I stated earlier. In terms of which customers and retail, I'm not going to get into a customer-by-customer kind of dissection of that. Understood. Thank you for that. And then you mentioned in your prepared remarks adding capacity in fruit snacks and in pet treats and dog food. Can you just discuss holistically across your business? How much capacity you are adding? And can you walk us through the planning and analysis that is done to determine, which categories that you choose to add more capacity in? Yes. From a high level, I mean the what I would tell you, the best returns that we can generate as a company are adding capacity on platforms that we already know and that are already growing. And the litmus test for me is that if they're growing before the pandemic and they're growing during the pandemic make the chances they grow after a pandemic are quite a bit higher. And you see that in our Pet food business. You see that in Fruit Snacks. You see that in Totino's, you see that in Old El Paso. And so, we have a variety of businesses. You've seen that in our Cereal business. And so, we have a variety of businesses that we've seen continued growth, and we've run out of capacity. And frankly, as soon as we've generated capacity, I think Fruit Snacks is a good example. We've added capacity and you will probably need more given the high level of demand. So that's kind of how we look at it. We make sure that all of these growth investments are value enhancing for our shareholders. But to the extent there are growth businesses and they are good margin businesses and all of the above or meet that criteria then we're more than happy to invest in our own internal capacity. Okay. I think that's all the time we have for this morning. So Kelly, I think we can go ahead and wrap up. Thanks, everyone, for the time and the good questions, and happy holidays to everyone. Thank you. That does conclude the conference call for today. We thank you for your participation, and we ask that you please disconnect your lines.
EarningCall_1434
Good day, everyone, and welcome to the Paychex Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, you will have the opportunity to ask questions during the question-and-answer session. [Operator Instructions] Please note, this call will be recorded, and I will be standing by if you should need any assistance. It is now my pleasure to turn the conference over to Mr. John Gibson, President and CEO. Please go ahead, sir. Thanks, Tadd. Good morning, everyone. Thank you for joining us for our discussion of the Paychex second quarter fiscal year '23 earnings release. Joining me today is Efrain Rivera, our Chief Financial Officer. This morning, before the market opened, we released our financial results for the second quarter ended November 30. You can access our earnings release on our Investor Relations website. Our Form 10-Q will be filed with the SEC within the next day. This teleconference is being broadcast over the Internet and will be archived and available on our website for approximately 90 days. We'll start the call with an update on the business for the second quarter and then Efrain will review our financial results and outlook for fiscal year '23. We'll then open it up to your questions. We delivered solid financial results for the second quarter with total revenue of 7% and adjusted diluted earnings per share growth of 9%. Demand for our comprehensive solution suite remains strong and we are well positioned to help our clients succeed. Our unique combination of leading HR technology, HR expertise and the wide breadth of solutions we have to address the many needs in the marketplace continue to help small and midsized businesses navigate this very dynamic and challenging environment. We continue to closely monitor the macroeconomic environment and our internal leading indicators. The latest findings from our Paychex IHS Small Business Employment Watch revealed moderating growth in jobs and steady growth in wages. Our clients continue to be challenged by the continuing impacts of the pandemic, inflationary pressures and the challenges of this labor market. However, small and midsized businesses continue to show their resilience. Our revenue retention remained solid as we focus on retaining clients and driving increased value and penetration of our HR outsourcing, HCM software and retirement solutions. Our overall HR outsourcing business continues to perform well with strong growth in worksite employees and record revenue retention. We achieved a major milestone this quarter. We now serve over 2 million worksite employees across our ASO and PEO business, clearly establishing us as an HR leader. Our industry-leading HR advisory services sets us apart and our certified HR professionals are truly a unique asset as they are advising our clients on HR issues as well as leveraging our HR technology and the analytics from our vast SMB data set to help our clients achieve greater operational efficiency, increase employee engagement and reduce turnover. While demand for our technology and HR outsourcing solutions remain strong, we continue to see shifts in what offerings clients find are the best fit for their current situation. Both early and during the pandemic, we saw lower demand for adding employer health benefits. We continue to see this trend and also high demand for our ASO solutions, driven by businesses seeking immediate assistance with HR issues and filing for tax credits, but delaying decisions on adding or changing their insurance offering to their employees. In addition, the lower medical plan sales and participant volumes in our health and benefits area of our insurance agency that we discussed last quarter continued in the second quarter, and we saw some similar trends in our Florida at-risk insurance program in the PEO, impacting revenue growth in that area of the business. Awareness and demand of our employee retention tax credit or ERTC service, which helps clients maximize eligible tax credits, continues to grow. To date, we've helped more than 50,000 clients secure billions in ERTC. A recent survey actually showed just 63% of business -- that 63% of business owners didn't even know that they were eligible for these credits. We continue to educate existing clients of the benefits as well as leverage this service to attract new clients. We continue to invest and enhance our product suite and customer experiences. In November, we released our enhancements to Paychex Flex, focused on further streamlining the recruiting, onboarding, time and attendance, and benefits administration experiences. Through our HR technology, three out of four Paychex clients surveyed have shortened the time required from recruiting, screening, tracking and onboarding new employees. Those clients reported an average time savings of 26%, indicating that the typical two-month recruiting cycle has now been reduced to just six. I'm very excited about our Retention Insights offering, which continues to deliver strong results for our clients at a time when businesses remain committed to retaining their existing staff. This feature uses predictive analytics, coupled with our vast data sets, to provide insights on potential employee flight risk. Clients leveraging the Retention Insights offering are showing a 15% reduction in turnover when compared against their industry peers. We're very pleased we received the Bronze Brandon Hall Group Excellence Award for Best Advance in HR Predictive Analytics Technology for this solution. This is the 10th consecutive year they've recognized us. During the quarter, we also were recognized with the IDC 2022 SaaS Customer Service Satisfaction Award for Core HR and we are honored to have received this award as another confirmation of the power of our HR technology and the quality of our advisory services. These awards continue to validate that Paychex is a technology leader and that our focus on HR is delivering real impact for our clients and their employees. At this time, we're heading into our critical year-end season. We are fully staffed in both sales and service, and we have good momentum. I want to thank all the employees in advance for all their hard work and dedication in making this the best year-end ever. Thanks, John, and good morning. I'd like to remind everyone that today's commentary will contain forward-looking statements that refer to future events. You know the customary comments. Take a look on our press release if you have any questions on that. Let me start by providing some of the key points for the quarter, and then I'll finish with a review of our fiscal 2023 outlook. Both service revenue and total revenue increased 7% to $1.2 billion. Management Solutions revenue increased 8% to $895 million driven by higher client employment levels and revenue per client. Revenue per client was positively impacted by additional product penetration. HR ancillary services, largely ERTC and price realization, we continue to see strong attachment of our HR solutions, retirement and time and attendance solutions. I will note that revenue from our ERTC service benefited second quarter revenue growth by approximately 1%. We anticipated ERTC revenue would moderate in fiscal 2023 but strong demand and execution have led to better-than-expected results. While ERTC was a tailwind to Management Solutions growth for the first half, it will become a moderate headwind in the second half. PEO and Insurance Solutions revenue increased 4% to $273 million, driven by growth in average worksite employees and revenue per client. The rate of growth was tempered by the impact of factors John previously discussed, including lower medical plan attachment and participant volumes along with the mix shift to ASO. And I would just note on PEO and Insurance Solutions, Insurance Solutions was significantly below the growth rate of PEO. Interest on funds held for clients increased 54% for the quarter to $22 million primarily due to higher average interest rates along with growth in investment balances. Total expenses increased 7% to $718 million. Expense growth was largely attributable to higher headcount, wage rates and general costs to support the growth of our business. Operating income increased 7% to $472 million with an operating margin of 39.7%, in line with the prior year period. Our effective tax rate for the quarter was 24.2% compared to 24.1% in the prior year period. Net income increased 8% to $360 million and diluted earnings per share increased 9% to $0.99 per share. Adjusted net income and adjusted diluted earnings per share both increased 9% from the quarter to $359 million and $0.99 per share, respectively. Quick summary of year-to-date financial results, total service revenue and total revenue both increased 9% to $2.4 billion. Management Solutions increased 10% to $1.8 billion. PEO and Insurance Solutions increased 6% to $556 million. Op income increased 10% with a margin of 40.4% with modest expansion year-over-year and adjusted net income and adjusted diluted earnings per share both increased 12% to $731 million and $2.02 per share. Let's look at our financial position. It's strong with cash, restricted cash and total corporate investments of more than $1.3 billion and total borrowings of approximately $808 million as of November 30, 2022. Cash flow from operations increased and was $686 million for the first half of fiscal 2023, and this was driven by higher net income and changes in working capital. We paid out quarterly dividends at $0.79 per share for a total of $569 million during the first half of 2023. Our 12-month rolling return on equity was absolutely stellar, 46%. Now I'll turn to the guidance for the current fiscal year ending May 31, 2023. Our current outlook incorporates our first half results, obviously, in our view of the evolving macroeconomic environment. We have raised guidance in many areas but moderated the range for PEO and Insurance Solutions based on factors previously discussed. Updated guidance is as follows: Management Solutions revenue expected to grow in the range of 7% to 8%. PEO and Insurance Solutions expected to grow in the range of 5% to 7%. Interest on funds held for clients is expected to be in the range of $100 million to $110 million. Total revenue is expected to grow approximately 8% other income/expense net. And I'd just remind you that the net of our debt service plus earnings on our corporate portfolios, that number is now expected to be income of $5 million to $10 million. Adjusted diluted earnings per share is now expected to grow in the range of 12% to 14%. Guidance for margins and effective tax rate are unchanged, although we do anticipate leaning towards the upper end of the range on operating margin and the lower end of the range on effective tax rate. Turning to the third quarter. We currently anticipate that total revenue growth will be approximately 6% and that operating margin in the third quarter will be in the range of 43% to 44%. Of course, all of this is subject to our current assumptions, which could change if there are changes in the macro environment. We will update you again on the third quarter call, and I will refer you to our investor slides on the website for more information. Thanks for taking my question this morning and happy holidays to you. I had a question on the insurance business. I'm just curious, you mentioned lower medical plan attachment and the mix shift to ASO. What do you think is the underlying driver there? Is there any other color or insight that you have in terms of why that sort of those dynamics are kind of kicking in right now? Yes. Look, I think I'll step back a little bit and then I'll zero-in on your question. I think our HR solutions, when you look at the combination of ASO and PEO, continues to grow at double-digit rates. We're very happy with the progress there. As we said, we surpassed the 2 million employees served. And if you go back and think about that, in fiscal year '19, we were at 1.2 million disclosed. So that's a 72% increase. And then you think about that, we had one year in COVID, where I think it’s probably like 3%. So very solid growth in both of those products. I think when you look inside, the agency has struggled. When you look under, there's a lot of economic pressure I think, on employers and employees. Most of our insurance agency tends to attract first time employers who are offering insurance for the first time, a lot of new business start type of driven activity. And I think in this environment, I think even though they would want to offer insurance to their clients, I think they're finding that it's economically difficult for them to think about adding that product. And then when we look at the participation rate, the other dynamic there is you need two things. One, you need an employer to buy it; and then you need employees to contribute their fair share. We've also seen some decreases in employees who are electing not to participate in their employer plans. So you have those two dynamics, I can't connect the two directly. But certainly, when I look at the hours worked, when I looked at inflationary pressure of wages, I wouldn't be surprised if that's some of the economic decision that's being made there. One follow-up for me. You also talked about Management Solutions higher product attachment cross-sell. Can you kind of update us on your strategy there? What levers you're using to execute on cross-sell and what inning we're in, in terms of that broader opportunity? Yes. Look, what we've seen across the board, our digital offerings, our online solutions continue to attract their driving efficiency inside companies. That's things that are looking for. You think about our time and attendance solutions. They're also dealing with more dispersed workforces. So that's driving demand, onboarding, recruiting and onboarding. So we still have a very tight labor market for small and medium-sized businesses. So our recruiting and onboarding experience has really driven demand, it's in partnership with Indeed. As a matter of fact, I think the last time we reported, we were somewhere around 1.8 million employees hired through this new onboarding -- hiring and onboarding experience, and we're approaching the 3 million mark in just six months since we last reported the number. So that's been very attractive as people are trying to attract and retain, and then our Retention Insights. So we go out, we have our HR professionals talking to our clients. It's interesting on the Retention Insights, we're actually doing behind the scenes insights to a data analytics team, and they were actually flagging clients that we think have an issue, and then we're proactively going out to them and having our HR consultants engage them in a conversation. Wanted to dig in here just on some of the leading indicators and the demand environment. So just since you reported last and then over the last few weeks, can you just talk about what you're seeing in that new demand across employer size as well and offering? Yes. Again, what I would tell you is, even though the -- it's a challenging and kind of a mixed macro environment, everything you read about the resiliency that we're seeing in the small and midsized businesses continues to be strong. So when we look at the leading indicators that we would be looking at of kind of the first signs of a downturn, we're simply not seeing those in our indicators at this time, and that's what we've reported here. I think there's certainly been a rare coaster effect from the COVID perspective. Certainly, when you look under the covers, I think our mid-market customers and larger customers seem to be doing better than our small customers and small customers seem to be doing better than the micro customers in terms of dealing with inflation and the recruiting scene. But when you look at the overall macro perspective, we're not seeing anything at this time in our indicators that would indicate any kind of downturn for small businesses. Okay. Okay. That's good to hear. I guess just a follow-up on that. As we think about the macro assumptions underlying the second half outlook, can you just talk about what you're thinking about for client employment levels, had a business client loss or things like that? I think pretty -- at this point, I think we're assuming an environment that's similar to what we saw in the first half. And with this caveat, Bryan, that as we've looked at quarter-over-quarter, you continue to see a pace that is moderating versus the previous quarter. I think that's the trend we think continues into through the end of the fiscal. So while it doesn't represent a sharp departure, we still see continuing signs of moderation as we go through the year. Now that assumed that the impact of the Fed's rate raising continues to have the same incremental impact it's had in the first couple of quarters. What do I mean by that? I mean, right now, what we see is it's having the effect of starting to tamp wage pressures. It's not having a dramatic impact on hiring especially in the SME firms that we serve. If that started to change, it would change our assumptions. Right now, we don't see that occurring. But right now, we're not at 5% short-term rates. We're going to have to monitor that. And there is just a note of caution that we have as we approach what they would consider their peak short-term interest. So no dramatic departure from the first half. I wanted to start just on Management Solutions with the raise of the revenue guidance there. Just which of the key operating metrics are you now bullish on? I mean is it pricing, retention, bookings, checks per client? Yes. So driving that, Jason, is -- let me pick a couple of those out and say where we're stronger, where it's not as strong. So obviously, we expect client retention and revenue retention to remain strong. It's strong and we expect that to occur during the balance of the year. We're seeing a little bit more increase in unit and unit churn on the low end, that's to be expected given the mix of the client base over the last couple of years, but it's coupled with very strong client retention, so higher value clients we're retaining, which is what we want to do. On the check question, that's a good one because in the first half, we saw good checks per for payroll or pays per control growth in the first half. We don't expect it to be that strong in the back half of the year. So we expect that it moderates as we get into the second half of the year partly compares partly simply because of the amount of growth that we saw last year. So that -- but it still will be a positive contributor. We think that ERTC will still be a factor in the back half of the year, although I called it out Management Solutions that's moderating. It just won't moderate quite as much as we perceive it to be. And then we consider the demand environment to still be positive and obviously think that sales will remain positive we go through the year. So that's a little bit more color on each of those. Yes. And Jason, I would probably add to that. I mean we continue to see the demand for our HR solutions, both ASO and PEO. We like the demand. What we're seeing an increase in worksite employees and the retention in those has been very I mean historic record high when you look at our HR outsourcing businesses, both of them at record highs. So we've had solid revenue retention across -- at the macro level. And then when you look at what's going on in the HR area, very, very positive results, and that's certainly helping us as well. Okay. Understood. My next question is just on the -- coming back to the insurance side of things. I mean, you talked about -- you talked about some macroeconomic effects that you think are causing that business to be a little softer than you would have anticipated. But are there any execution issues you feel you need to take a look at or anything that could border on structural challenge vis-a-vis cyclical. Just wanted to see if we can unpack that a little more? Yes. Well, Jason, let's talk a little bit because we've talked about the agency a little bit. I mean P&C has been a continued product. Again, remember, most of our P&C business is workers' comp, the vast majority of it to new start-up businesses. And that's been a very soft market for a period of time. So certainly, that has continued to be a drag and that has not turned around. I think when you look at the H&B side, which has been a little bit more impacted up and down as you went through this pandemic. It's what I kind of say, you have a little slower new business starts, so people less people we're talking to, and then you have the economic pressure of adding a benefit at that cost both from an employer and employee side. So I don't think there's anything terribly structurally. Now one of the things we're certainly doing is we're trying to make adjustments to our approach both in terms of driving more digital engagement on the P&C side. We're also doing a lot more going back to current clients on the H&B side, where we think we may have more success in converting them from existing benefit programs. And we're going to continue to look at expanding our insurance product portfolio to meet the demands of the marketplace with some things that may be more economical. But again, this is really a continued sluggishness with P&C and then this kind of lack of attachment and backup participation in H&B. Happy holidays, and John, congratulations on the first call. I wanted to drill into the puts and takes on the guidance a little bit. I mean, there's been a pretty sizable step-up in float, which is pretty profitable. And then the swing factor on the other income is pretty profitable, too. But we're kind of holding the EBITDA and I know the other income is below the line, but the floats above, is there anything offsetting that, Efrain? Or is that a little conservatism? Just -- because it seems like your overperforming in some of the more profitable parts of the business as opposed to not and it doesn't seem like that's flowing through. So is there anything I'm missing there or just not thinking about that right? No, no, not really, Kevin. I mean I think when you do the arithmetic, what you end up and the color that I gave you was that we saw ourselves more towards the top of the range. So there is flow through on that revenue. And in the back half of the year, we don't assume that 100% floats through, we look at the year position ourselves also to anticipate potential spending going into '24. We may end up outperforming that number but at this point, we do always approach with an element of caution and conservatism as we go through the year. That makes a lot of sense. And then can you remind us, Efrain, just what Fed funds is in that $100 million, $110 million in terms of from a Fed funds perspective? Yes. We assume we're going to end up close to where the Fed is around a 5% terminal rate as we get into the spring. The -- I just caution that you can't simply take the portfolio and put that rate in because it will depend on what the balance between short term and long term is. And I've been saying throughout the year that what I want to do is position the portfolio. So we don't -- so if we're in a situation where the Fed decides to raise and then suddenly sharply cut, we're a little bit more protected than we were during the last cycle and when the same thing occurred. So -- but obviously, we're flowing that through the P&L. Maybe just on the record sales performance. I guess, can you comment on bookings activity, both in aggregate and then maybe the linearity of the quarter and what you're seeing as we get closer towards the end of the year and as your clients adjust to maybe the changing macroeconomic environment? Yes. So we -- look, we continue to see very strong demand for our products and services. As I said, continue on the HR side, continue to see strength there, all of our digital products. We're not seeing a lot of change in the competitive landscape at this point at all. Again, we continue to find our clients are really struggling with dealing with inflation. And certainly, our technology solutions are making them more efficient. So we've got a definitely efficiency play there. We're also helping them with the ERTC. Again, remember, I think our average is over $150,000 per client that we're helping them. We've helped 50,000 clients, and that's become a big economic help to them. That's helping us. We continue to see strength in the 401(k) business as well as an attachment, a critical benefit that people want to have, their state mandates and that's becoming very popular as well. I mentioned time and attendance and all of our online services, this comprehensive group of online digital experiences that we're rolling out from recruiting. All of those are really resonating with the problems that small businesses are happening. So to your question, by the way, I think you had me stumped there for a second as to the linearity of it. Here's my answer to that and you can tell me if I answered it correctly. So if I look at first half sales bookings growth, it was certainly solid strong. And you have to go back to how are we comparing now on the two-year stack pre-pandemic, and we compare favorably certainly to that period of time. But the question for this business is, as everyone on the call knows, Q3 is a really important quarter, our most important quarter. So generally, when we line up strong in the first half, we end up strong in the second half when we start to lob a little bit in the first half, a little bit tougher in the second half. I think to John's point, we're well positioned for the selling season. The only caveat I would have is that we have to get through the selling season to see how we come out to really kind of get a sense of where the year was by the time third quarter has rolled through. We're pretty much -- we pretty much know where we are for the year. So I think we're lined up well. I think the numbers would suggest that, and we're in the middle of it, won't report, part out more in the third quarter. And then maybe just, I guess, a follow-up on your own. I think that's about what your customers are doing. Just -- and you said that you're at the expected staffing levels. How are you thinking about your own maybe hiring going forward in the sales and marketing organization? How are you guys planning for based on the assumptions you made in your own guidance as well? Yes. As we said, we're fully staffed, both in sales and service going in to the selling season, which is exactly where we want to be given the demand that we're seeing. And we're going to continue to monitor that. We're being very cautious in adding above that at this point in time. I would say we do see some opportunities for investment. As Efrain said, and we will make those investments in the selling season if we see the opportunity to promote certain products and services that we think are resonating in the market. So we're holding back to be able to do that. If we see some sort of change, we know what the levers are. As we've said, we're the best operators in the business. We're going to continue to do that. We've got our hands on the leverage, but we're not pulling them at this point because we're just not seeing that decrease in the demand that would merit that. Efrain or John, just thoughts on pricing, how it's taking? I know, John, you said the competitive environment isn't changing. So I'm wondering customers have reacted to the most recent price increases that you had to put in? Well, Kartik, I would say our average revenue per client is double digits. It's above even any of the pricing levels, and that's really driven by the value we're providing. And we've already talked about it, the attachment, the upgrading we're doing from the HCM to the HR solutions, the attachment we're seeing from our digital experiences that we're adding. So from a revenue per customer as well as a revenue per new sold customer, we actually are doing very, very well there. So I think it demonstrates the value and I think it demonstrates the pricing power that we have. And then just looking at the balance sheet. Obviously, the balance sheet is in great shape. And if the economy slows and maybe valuations come down, just your thoughts on maybe buying back stock versus M&A opportunities? What makes more sense for Paychex? I don't think anything has changed, Kartik, in the sense that if the right opportunities for M&A came along, we would obviously be constructive on those opportunities. We have a range of opportunities in the funnel that we're looking at. And sometimes we see opportunities that may be worth going after more aggressively at this point. I think that we have the normal set of opportunities that we have in the funnel. With respect to buying back shares, I don't think we've changed our outlook in terms of at this point buying back based on our desire to combat dilution. So I don't think a lot has changed in that sense. I do think the environment -- and John can also talk to this, but the environment looks more productive for doing both tuck-in acquisitions and a little bit larger scale M&A. And we're very interested in doing that. Yes. I think to add on to that, Kartik. Look, I think the market is changing for sure. We've always, I think, had a very similar position. The position has not changed. I think the opportunities are changing, meaning they're presenting themselves of more reasonable valuations. We always are, I think, known to be very conservative and good allocators of capital. And it's not that we've not been interested in doing M&A or going after some technology bolt-ons but the valuations have just been unreasonable for us to be able to cross that barrier. And at least what we're seeing is we're starting to see some moderation there. And we're going to continue to be as active as we have been in the past. And hopefully, we can get to a point where the market valuations match what we think is a reasonable amount to pay for some of these businesses that we're interested in. Just thinking about wage inflation or just inflation in general. What's the direct effect for Paychex? Is it less attachment, less spending from the client that you'll end up seeing? Well, so let's talk about wage inflation. First of all, I'd probably tell you that we have wage inflation, but it's been moderating. If you look at our Paychex IHS index, we've been steady for the last three months at about 5%. And that's actually kind of moderated a little bit from the increases we were seeing before. When you think about the wages in certain parts of our business and certain pricing models in the PEO in particular, some of our pricing is based on a percentage of wage, similar to what's in the industry. So that can have some uplift. But in general, the wage rate does not have a big impact on our revenue. Not really. I don't see that. I would have never seen that analysis that would indicate that. The one thing I would probably say, look, the number of employees, worksite employees is the key driver in our HR businesses, checks in the payroll side of the business, the more people that are employed, the more people that are getting checks, the better. One of the things that I would tell you is that we're seeing in terms of the impact of inflation on employees is they're now working more hours. That's one component that we see. A recent survey of the American Association Staffing actually found is 58% of adults are looking at potentially adding a second job we are beginning to see people getting checks at two different places within the client base. As you can imagine, that's a check as a check. And so again, if you see that type of -- where people are going and working more, working in more places, getting more checks, that's positive for our business. Got it. No, that's helpful. And then obviously, as you guys talked about the key selling season is happening over the next few months. What are your guys' expectations for new client growth? Is it -- I always think about 2% to 4%. Is it high end, low end of that as you head into the season? Well, so Bryan, I think typically, we say 1% to 3%. We will see where we come out of the range there. We expect it to be a good season. I think that's about as much what I can say as we're in the midst of it. I wanted to come back to the PEO insurance for a second, if you don't mind. A lot of questions have been answered on the insurance side of things. But I wanted to just double click on the PEO specifically. So putting the agency aside and even putting the issues with insurance attachment aside, which was talked about, can you just comment explicitly on what you are seeing in the bare bones PEO business, literally PEO works at employees, bookings trend there? I think that would be very helpful. Yes. So I'll let John talk to sales, but I think that's a great question. And I just want to take a second to kind of, as you said, double, double click on the PEO and the elements of revenue that affect revenue growth there. So if everyone on the call knows the first thing in that, that revenue in insurance in the PEO is primarily derived from the State of Florida on the health care side. Workers' comp is different, but on the healthcare side. So it's a big number, but it's primarily going to be influenced by Florida. To John's point, we anecdotally saw some interesting things in the first half of the year where we had people who have insurance stayed with the PEO, but decided they didn't want insurance. And it was a little bit of an unusual situation. We didn't call out specific characteristics of the State of Florida in the first half of the year because, frankly, don't want to pile on that excuse as to what happened there, but Florida had an unusual idiosyncratic period in the first half of the year. Long story short, the level of attachment that we expected to see in that state in particular, didn't materialize. As I looked at it and we looked at it, we said what makes sense? Well, we don't expect, we expect the second half revenue in PEO will be stronger than the first half. But we're a little cautious based on what we're seeing with respect to insurance attachment. And so that's why we had an abundance of caution. We lowered the range for revenue on PEO in the second half. I think it's really important, all of that is the punch line to make this point, has no impact on margins or on net income. So we could easily have 5% or 6% PEO growth and have 8% or 9% depending on the on the mix of revenue, insurance versus admin that wouldn't have any impact on margins. So that's largely driven by softness on that side of the business, and I could be reporting, and we could be reporting them in the fourth quarter. We had a really sharp spike in insurance attachment. That's the reason we manage the business the way we do. We're not expecting to make money out of there. Obviously, we'd like it to be a bit higher than it is. But I think it's really important to remember that worksite employees, that's an important point. What we're seeing is we're seeing solid growth of worksite employees and PEO in the PEO business, which is one thing that encourages me in terms of the back half of the year. So we're not seeing softness in terms of worksite employees, and that's really the driver of profitability in the business. You don't have the work sites, you're not going to have it. So it's a little bit digging in, you asked the right question. when you look at it, it really -- the fundamentals beneath the issue of insurance looks solid. I'll let John talk to what's happening on the sales side? Yes. No. Look, our -- to Efrain’s point, this insurance attachment thing is localized to Florida. Our attachment rate in the PEO for our clients in Texas has no impact on our revenue at all. And so the fact that it does in Florida has an impact. But look, I think the PEO value proposition is still strong. It's still very solid. You look at evidence of that. I look at our revenue retention and our retention of clients there is at near record levels, very strong. We continue to see a strong worksite employee growth. And so again, I feel really good about where we are positioned. We're fully staffed there. We're into the selling season and very confident that we have the right products and services for that market. So again, if dynamics in the market change, I would expect those are going to impact others just like they impact us. Got it. Got it. Well, very comprehensive double-click, very helpful. And then for my follow-up, actually, I wanted to ask on the kind of HR management side of things. On a competitive landscape, I was curious if you can provide your thoughts on any competitive pressure you're seeing from the trend of embedding payroll into software solutions. So we're seeing, obviously, a lot of the payments providers, software providers looking to expand their offerings with other business modules, if you will, and payroll is always at the top of the list. They talk a lot about that. I was curious from you guys side, how successful do you think those efforts are? And are you seeing any competitive pressure? I would say that I've not seen a dramatic change in anything and not seeing any type of new entrants that are worrisome in terms of what I think about our growth. I think -- probably the other point I would make is that one of the things I think we will -- it will be interesting to see as we go into the selling season is some of the upstart competitors who don't need to necessarily make money whether or not they'll still be able to approach the market and marketing and marketing spend, et cetera, in the same way they have in the past. So we've already seen, I think, some of that dialing back. So not that I'm seeing in any of the data that I see that I'm seeing them having an impact. And Eugene, I'd go back probably three, four years ago and one of the fintech providers embedded payroll and our stock traded down, I don't know, like 3% in the day, and I was getting calls about why and said look, such and such has an embedded solution on payroll. I think look, the surest way to stumble is to act arrogant, and we're not arrogant about those folks. We've looked at, by the way, some of the people that you cover and think there's an opportunity in the market for those solutions. They're just not a dramatic impact. We've never seen a dramatic impact on us because the other thing you need to think about or the other thing to consider there too is depending on what part of the market you're addressing there. Especially in [loan], there's a benefit to having some level of service attached to payroll, not obviously in the enterprise space or in the upper end of the market. And that ability for simple payroll, we've got that pretty much covered which were payroll. Welcome, John, and happy holidays to all. Efrain, I wanted to ask a question about -- you called out working capital as a benefit this quarter. Wondering if that's indicative of changing activity with some of your staffing clients? And if that's a tail even to perhaps what's going on more macro-wise? And then I just had a quick follow-up. Well, great question, Pete. So the short answer to that is if you look at the first -- at the comparable period last year, the staffing business really rebounded significantly. And so we had a net use of working capital as the receivable balances grew. The staffing business continues to be pretty strong, staffing funding business, just so everyone on the call that's our Advance Partners business. But we're not -- we don't have the growth in receivables that we had last year. So as a consequence from a net in change in working capital perspective, we didn't have that use of funds. So that's really what's driving it. And just a quick advertorial on the staffing funding business, it's doing well and we're continuing to see growth in that part of both our business and the market as a whole. And then I just want to follow -- dig a little bit deeper into the last question, particularly dealing directly with merchants, on the merchant side, how are you guys -- are you guys pleased or wondering if you just qualify how things are going with channel sales? And I know you have a relationship with Clover, and I think you have some other channel distribution partners. Just if you could talk about the sales efficiency that you're seeing there, that would be helpful. Yes. I would say in our business development, we're continuing to add additional channels. It's still, I'd say, a small portion still when you look at where we're getting our clients is from our CPA partners, it's from our existing clients referring us. It's from digital marketing. And then we have a cadre of business development, we continue to add to them. So we continue to do that. I'd say I'm pleased, but I'm not saying that I see anything. Again, it goes back to my prior comments. I've not seen a major shift which says, "Oh, my goodness, this is a big emerging trend or emerging threat." They're incremental, they're helpful. There's obviously a segment of the market that looks for that type of integrated solution and as Efrain said, as their needs get more complex, what we tend to find is they migrate into one of our HCM solutions and are getting into our HR products. I know I don't know if that makes sense. If it's simple, if you're looking for something very simple and the integrated is important, the minute you have one of these modules that sort of add-on and then you get into complexity. That's where the service model kind of breaks down and you kind of see this unbundling start to occur. So there's a portion of the market that I think it makes sense for. We're continuing to look at that. But again, when we look up at particularly our HR businesses and where we're seeing the need for our digital offerings, not so much. I think it's less important to those clients. Great. And just a couple of follow-up questions for me. First on margins. It seems like we're pretty near peak levels right now. How should we think about the durability of these margin levels going forward? And particularly, a question we get a lot is if we were to see a recession, and revenue growth were to be impacted, what would -- how should we anticipate that would impact margins? And what levers do you have to get us to the higher end of your margin outlook versus perhaps going back to the lower end? Yes. Let me answer it two ways and then I'll put it over to John. Look, I think, James -- and we get the question a lot, I think it's part of the transformation that the company has gone through over the last year, last, I would say, five years, in particular, especially post I'd remind everyone of the investments that we made post tax reform and that we delivered on. Our intent was to accelerate the transformation to look much more like a technology company than what we had been before, which was certainly a perfectly well-functioning tech services business but more technology. So you hear a lot of what we say, but don't, I think, see the background of it as much. We deploy a lot of technology in the background. And I say this in many of the calls where today's tech service is tomorrow's technology delivered by a set of technology tools on the back end. And we feel really passionate about the ability to deliver service but service delivered through state-of-the-art technology. What's the point of all of that? The point of all of that is that if you can do that and if you can do it successfully, then you get margin expansion of the type that we have been driving. We think there's still a long road to go in terms of our ability to fully optimize and digitize everything that we're doing. And as a consequence, we challenge ourselves every year to look at a range of potential investments that can drive margin improvement balanced by investments that also drive revenue growth. So we're trying to play those off. And the short answer is, yes, I think if you were -- five years ago, if you said we'd hit 40%, and then we'd be talking about the potential to expand beyond 40%, look, I wouldn't have known that with precision that we were going to be there, but that's exactly where we're at. There may come a day where we say, "Hey, look, I don't think for the growth of the business, the level of investment we need to make in the business, we can really continue to leverage." But we're not at that point at this stage. I'll turn it over to John for comments too. Yes. I think you covered, Efrain. I mean I've said from the start, we are known as the best operators in the business, and that's something I'm very proud of to have been part of. And it's in our DNA, and we're going to continue to do that. And I do think we have some macro opportunities, and that is the digital adoption that's happening in the marketplace is a benefit. Employees and employers don't want to talk to us anymore. They want to get on our 5-star app, and they want to be able to do it themselves whenever they want to do it. That adoption helps them and it helps us. It provides a better client experience. We're investing in that, looking for ways to drive efficiency there. So that macro adoption and then what we're doing in digitizing our back office is another opportunity at different points, but I think we're still -- we still have runway on and we're still continuing to invest in and push in and continue to move on. So I think there's plenty of opportunity for us to continue to look for ways to not only provide digital solutions to our clients but also continue to digitize what we're doing in the back office. And that's in areas of the business. I mean you look at our digital sales unbelievable growth in that mode of selling over the last decade and over the last five years as we've invested in that. We've launched a digital onboarding capability that will be fully operational for the low end of our market across the business starting in January. So looking forward to that test and learn. And we have several other test and learn investments coming out of our November strategy session that are all built around driving additional growth and driving further digital adoption across the business. That's helpful. And I guess a related question. I mean, it sounds like you guys are going into the selling season well-staffed, and I know that has been a point of concern earlier. But I'm just on that topic and more broadly of service levels. I guess are you seeing that as an indicator of just a little bit of a change in the hiring market generally? And then on -- and as we dig into the efficiencies, are the technology investments, et cetera, allowing you to increase the typical client count for an existing account manager? And how has that been trending? Just wondering about kind of the hiring environment for your own needs as well as points of efficiency that you're realizing right now? Yes. I would say the hiring environment for us. I think like most people reporting has stabilized, much different than it was probably a year ago when we were sitting here a year ago, we were not fully staffed to where we would like to be entering the selling season and the year-end season. And we sit here today, fully staffed, fully trained and prepared to execute going into that. So it's a much different hiring environment for us as well. And we are continuing to drive productivity as well. Happy holidays, John and Efrain. I just want to save you a little effort. I've got a little gift for you, just to save you some time on all your callbacks, because I'm getting this question a lot on live. Can you just break out the PEO and Insurance Services, that $273.3 million? Can you break it out between the agency component versus the PEO component? And then... And then to break down what you ended up seeing in terms of the year-over-year change within those and this is more than double clicking, but it will save you a lot of time. Just how much of an impact there was with regards to the change in terms of the uptake of the health insurance and the property and casualty, the workers' comp? Yes. So Mark, I would point all of the good investors who are asking you those solid questions to a chart that we included at the beginning of this fiscal year, end of last fiscal year, which broke out PEO and insurance by percentages. So if you go there and look at that, you'll see the exact percentages and the percentages as of the end of the year really didn't change significantly in the first half of the year. So that's the first part. The second part is roughly half and half is H&B and half -- I'm sorry, roughly half of the insurance revenue is H&B and the other half is P&C, as John said, but that's largely workers' comp insurance. And so I will only describe it qualitatively, which is to say that we're still seeing growth low single digits on -- I'm sorry, we're still seeing growth in H&B and on a P&C -- P&C itself workers' comp in the quarter was flat to down. So the impact of a really soft insurance market, which was different than it was three, four years ago is weighing on that. So in summary, I would say, look at the end of the quarter, end of the last fiscal year, I got a breakout on Management Solutions and also on PEO and insurance, it's there. You'll see what it is. And then you can say that in the insurance, roughly, it's half workers' comp and half H&B. We still see growth in H&B, and to John's point, that should grow as smaller clients become more constructive on buying insurance. Workers' comp is the one that's exerting a drag on that entire segment. Got it. And if we strip out the insurance component, is the PEO business ex the insurance component still growing high single digits, low double digits? I won't split it out that way because it's a little bit tough with the value proposition, Mark. What I'd point to is what I said earlier in the call that we're getting good worksite employee growth, and that's kind of where we're focusing it. It's hard to strip it out that way because then you'd have to do a deep dive on what's happening in Florida versus other parts of the market. But when you look across of the markets that we serve and look at worksite employee growth with -- and certainly in most of the major markets, we're seeing good worksite employee growth. And what was -- I'm sorry, I'm sure you mentioned it before, it's in one of the releases, but what was the worksite employee growth? We did not say that. And good try, though, Mark. We didn't say it. We'll report on it at the end of the year. What we did what we did say and what John said is that we've had significant worksite employee growth, both in the ASO and PEO model, and we surpassed 2 million to 1 million employees. Remember, Mark, one other thing for everyone. We don't force a client into either the PEO or ASO, we're unlike a lot of other providers. So we say to a client, you can have either depending on what you value in the bundle. And so what we're seeing across both of those solutions is strong demand. Great. And then on Managed Solutions, obviously, solid and better than expected, better than what we modeled and better than what you've guided. But one question that I got from some investors is basically why did Management Solutions slow in Q2 relative to 1Q? Okay. That was a good question. I answered that one after first quarter. But the short answer to the question, Mark, I'd say, bucket it three ways. And the first thing is that significant growth in pace per control or checks per payroll in the quarter versus the prior quarter. That was one. The second part was that ERTC was a significant contributor in the quarter. It wasn't as great a contributor in in the second quarter. In other words, it wasn't as large incremental growth. And then third was everything else, which was positive. Got it. Great. And then, John, you mentioned the really cool innovative tools during the last quarterly discussion, particularly the voice activated solution. I'm wondering if you can give us a sense for like for your most innovative tools, what sort of uptake are you currently seeing? Well, I mentioned one where clients are having the issues, which is really on the hiring and onboarding is one. So if you look at that when we last reported, I mentioned that we had launched that product in beta and then announced it. At that point, we had 1.1 million -- I think it’s 1.8 million maybe employees that had actually been hired through that process. As I sit here today, we're we will approach 3 million people hired to that platform. So give you some idea of the use of that, how frequently that's being used, and that's very popular. The Retention Insights is another one that we've had very good uptake and utilization of and the impact, quite frankly, so getting good reviews there. Yes, yes. So we launched that. It's -- we're just starting to launch that, and we're watching to see how customers adapt to it and utilize it. I just wanted to ask on the retention side. I know it's record retention, has been doing really well. And I've been getting a lot of questions around SMB and retention, bankruptcy risk here going into possible recession? I know Efrain, you've shared this before. But can we revisit what it did in past downcycles. And I would imagine that you would do probably a little bit better. I think you always do a little better than people here. But I would think you would do better here given the shifts in the platform, the investments in tech. So -- but I just want to revisit that before we close out the year. Yes. Yes. So I mean if you go back to '07, '08, '09, where the business was rough -- Tien-Tisn you would know, this was roughly about 80% payroll and 20% HRS, I think get about troughed, I guess, depending on which side you're looking at, at about 77% retention on a unit basis. I don't know what the revenue retention was back then. But we were down to about 23% attrition. Now there were a lot of reasons why that's certainly a lower, lower, lower, lower band. But not to mention the fact, Tien-Tsin, as everyone on the call knows that right now, if we just isolate pure what we would call payroll, that's less than half of what we sell. So the rest of the stuff when you act in our model creates and generates better retention. So now you put yourself in a completely different position even in PEO. So I think the factors there dictate that you're going to have a very different outcome than you would have back in '07, '08, '09. One other point that I would add to that. I mentioned in the -- during my comments that we did see -- we are seeing more elevated churn in the micro segment than perhaps a year ago. There's a mix element to that that's not -- if you want to understand and call me, it's not worth going into here. But from the -- and we anticipated that, by the way. But from a revenue retention standpoint, we still are very, very solid. And those are the clients that you're less likely to see churn in a downturn. So that's my long-winded answer to your question. And my quick follow-up. I know there's a lot of margin questions here. The overperformance in the first half, any sub prices or what would you attribute or rank, the big contributors to the margin overperforming here so far? Yes. Tien-Tsin, I hate to use kind of a very generic answer to the question, but it is the very generic answer to the question. We had an expense plan and would beat it. So there was some mix effect. I mean, I don't want to say that Management Solutions overperforming the way it did, in fact it did. So I think that's part of it. But also expenses were better in the first. Thank you. And we have no further questions at this time. I'll turn it back to Mr. John Gibson for any additional or closing remarks. Thank you, Tadd. Well, at this point, we'll close the call. I would like to thank you for your support during my first call as President and CEO. I look forward to getting to know each and every one of you better in the future. And we've got a chance to talk to some of you, I'm sure we'll get a chance to talk to more. If you're interested in a replay of the webcast of this conference call, it will be archived for approximately 90 days. Again, I want to thank you for your support of Paychex. I hope all of you and your families have a happy holiday and Happy New Year.
EarningCall_1435
Good afternoon, ladies and gentlemen and welcome to Cathay General Bancorp’s Fourth Quarter and Full Year 2022 Earnings Conference Call. My name is Sarah and I will be your coordinator for today. [Operator Instructions] Today’s call is being recorded and will be available for replay at www.cathaygeneralbancorp.com. Now, I would like to turn the call over to Georgia Lo, Investor Relations of Cathay General Bancorp. Thank you, Sarah and good afternoon. Here to discuss the financial results today are Mr. Chang Liu, our President and Chief Executive Officer and Mr. Heng Chen, our Executive Vice President and Chief Financial Officer. Before we begin, we wish to remind you that the speakers on this call may make forward-looking statements within the meaning of the applicable provisions of the Private Securities Litigation Reform Act of 1995 concerning future results and events and that these statements are subject to certain risks and uncertainties that could cause actual results to differ materially. These risks and uncertainties are further described in the company’s annual report on Form 10-K for the year ended December 31, 2021, at Item 1A in particular and in other reports and filings with the Securities and Exchange Commission from time to time. As such, we caution you not to place undue reliance on forward-looking statements. Any forward-looking statement speaks only as of the date of which it is made and except as required by law, we undertake no obligation to update or review any forward-looking statements to reflect future circumstances, developments or events or the occurrence of unanticipated events. This afternoon, Cathay General Bancorp issued an earnings release outlining its fourth quarter and full year 2022 results. To obtain a copy of our earnings release as well as our earnings presentation, please visit our website at www.cathaygeneralbancorp.com. After comments from management today, we will open this call up for questions. Thank you, Georgia and good afternoon everyone. Welcome to our 2022 fourth quarter earnings conference call. This afternoon, we reported net income of $97.6 million for the fourth quarter of 2022, a 29.6% increase as compared to a net income of $75.3 million for the fourth quarter of 2021. Diluted earnings per share increased 35.7% to $1.33 per share for the fourth quarter of 2022 compared to $0.98 per share for the same quarter a year ago. In the fourth quarter of 2022, our gross loans increased $147.2 million or 3.6% as annualized. The increase in loans for the fourth quarter of 2022 was primarily driven by increases of $116 million or 5.3% annualized in commercial real estate loans, $122.3 million or 9.5% annualized in residential mortgage loans. The overall loan growth for 2023 is expected to range between 3% to 5%. We continue to monitor our commercial real estate loans. Turning to Slide 8 of our earnings presentation, as of December 31, 2022, the average loan-to-value of our CRE loans was 51%. As of December 31, 2022, our retail property loan portfolio, at Slide 9, comprises 22% of our total commercial real estate loan portfolio and 11% of our total loan portfolio. The majority, 89% of the $1.96 billion in retail loans, is secured by retail building, neighborhood, mixed use or strip centers and only 10% secured by shopping centers. For the fourth quarter of 2022, we reported net charge-offs of $2.5 million, which included $2 million that were fully reserved as of September 30, 2022 compared to net charge-offs of $0.6 million in the third quarter of 2022. Our non-accrual loans were 0.38% of total loans as of December 31, 2022 increased by $3 million to $68.9 million as compared to the end of the third quarter of 2022. Turning to Slide 12, as of December 31, 2022, classified loans increased slightly to $256 million from $240 million as of September 30, 2022 and our special mention loans increased to $321 million from $305 million as of September 30, 2022. We recorded a provision for credit loss of $1.4 million in the fourth quarter of 2022 as compared to a $2 million provision for credit losses in the third quarter of 2022 and $3.5 million provision for credit losses in the fourth quarter of 2021. Total average deposits increased by $387.5 million or 9% annualized during the fourth quarter of 2022. Average time deposits increased $1.4 billion or 99.2% annualized during the fourth quarter of 2022 compared to the third quarter of 2022. Average money market deposits decreased by $802.8 million or 73.1% annualized due primarily to a migration back to CDs from money market deposits and deposit runoffs. For 2023, the overall deposit growth is expected to range between 3% and 5%. I will now turn the floor over to our Executive Vice President and Chief Financial Officer, Mr. Heng Chen, to discuss the fourth quarter 2022 financial results in more detail. Thank you, Chang and good afternoon everyone. For the fourth quarter of 2022, net income increased by $22.3 million or 29.6% to $97.6 million compared to the fourth quarter of 2021. The increase was primarily attributable to net interest margin expansion in the fourth quarter of 2022 compared to the year ago quarter. Our net interest margin was 3.87% in the fourth quarter of 2022 as compared to 3.23% for the fourth quarter of 2021. In the fourth quarter of 2022, interest recoveries and prepayment penalties added 1 basis point to the net interest margin as compared to 3 basis points for the third quarter of 2022 and 6 basis points for the same quarter a year ago. Based on Fed Funds target range of between 4.75% and 5%, we have increased our net interest margin expectation for 2023 to be between 3.75% to 3.85%. Our 2023 net interest margin expectations included the impact of the $3.1 million interest recovery from a full repayment of a non-accrual loan last week. Our non-interest income during the fourth quarter of 2022 decreased by $7.7 million to $12.1 million when compared to the fourth quarter of 2021 due to an increase of $3.2 million in loss on equity securities, a decrease of $3.1 million and the gain on venture capital investment, distributions and a decrease of $1.7 million in derivative fee income. Non-interest expense increased by $8 million or 11% to $81.1 million in the fourth quarter of 2022 when compared to $73.2 million in the fourth quarter of 2021. The increase was primarily due to $1.2 million in higher salaries and bonuses; $3.8 million in higher amortization of low income housing and solar tax credit investments, which included a $1.3 million catch-up adjustment in the first quarter; $1 million in higher amortization of core deposit intangibles, which included approximately $900,000 in accelerated write-downs; and $1.1 million in higher professional and marketing expenses. Special items in the fourth quarter 2022 once again included a $1.3 million catch-up adjustment for impairment of low income housing investments and $0.9 million of additional CDI amortization. We expect core non-interest expense, excluding tax credit or deposit intangibles and amortization and HSBC integration expenses to increase 3.5% from 2022 to 2023. The effective tax rate for the fourth quarter of 2022 was 25.7% as compared to 23.6% for the fourth quarter of 2021. For 2023, we expect an effective tax rate of between 17.5% and 18.5%. We expect 2023 sole tax credit investment amortization of $30 million which is $10 million in each of the first three quarters of 2023. As of December 31, 2022, our Tier 1 leverage capital ratio increased to 10.08% as compared to 10.02% as of September 30, 2022. Our Tier 1 risk-based capital ratio increased to 12.19% from 12.06% as of September 30, 2022. And our total risk-based capital ratio increased to 13.71% from 15.59% as of September 30, 2022. Great. Good evening. Heng, I want to make sure I understand the expenses, just to make sure I’m buttoned up on the expenses. The 3.5% growth, is that off the – it looks like the $255 million, and then I’m adding on top of that $30 million on solar. Is that right? Okay. Great. And then maybe on the margin guide, you had a pretty decent mix shift this quarter. So I’m interested in what – I guess what further remixing you might be forecasting in the CD portfolio. How much more do you have that increasing proportionately to get to that 3.75%, 3.85% margin? Thank you. Yes. We – pre-COVID, we used to do Chinese New Year promotions, and so we’re in the third week of our Chinese New Year promotions. So the average rate is – we have two tiers, but the average rate is probably about 4.20%, and we were very pleased with the results of that. We think we will get net new funds into the bank of at least $600 million. And so in terms of context, one, your broker CDs would be at 4.85%. So our rate is 4.20%. And we’re borrowing from a federal home loan bank. We’re borrowing them short-term. So that rate was about 4.8%. It’ll go up to 5% in February when the Fed increase changes. So we think that to help, lack of better word, deliver a good margin in Q1, plus that $3.1 million interest recovery would add 6 basis points to that. But once again, we had one quarter, on our Slide 15, it shows the average Fed funds versus a cost of interest-bearing deposits. So for 2022, our deposit beta was 34%, and it jumped up to 61% in the fourth quarter. But once again, we think the first quarter, the deposit beta will not be 61%, and we have two prime rate increases in Q1. So our loan beta is 44%, and that should continue. So once again, that’s why we think we will be in the range where we’re going to be. Okay. And if I could just make sure I’m totally buttoned up. The interest recovery, is that in the 3.75% full year guide, 3.85%? Okay. And then the mix of deposits, right? CDs are 38%. I think pre-COVID, it was north of 40%. I mean the expectation is that we’re perhaps approaching 50% by the time the Fed’s done. Is that reasonable? Or is that too far? I think that’s too far. But if the Fed’s not done, it’s going to help us NIM-wise, net interest income-wise, in 2023. And we’re going to be focusing on 2024 when we had to reprice these CDs downward, which we think we can. Hi, good afternoon. I just want to round out the NIM discussion a bit here. Do you have the spot rate on interest-bearing deposits at the end of the year to give us some visibility going into 1Q? Okay. Makes sense. Okay. And it sounded like the expectation is the overall NIM kind of hangs in there in the current range. So I don’t need necessarily a monthly NIM, but if you had the December monthly NIM, I’ll take it. Yes. Yes. It’s – it was down slightly from the full quarter NIM. It’s – so the December NIM, that’s a 31-day month. So that was 3.81%. Okay, thank you. Got it. And then just on the overall reserve dipping down a little bit here, 80 basis points. Can you give us a sense for what you considered in terms of macro factors? What’s your overall unemployment rate outlook for this year and how you might be weighing kind of the baseline versus adverse scenarios? Yes. Matthew, as I might have mentioned in the past, we use a blended rate for – until the fourth quarter, we were at 30%, 40%, 30% Moody’s rating, where the 30% is the S1, the Moody’s S1, which is the most favorable forecast. The base is their base. And Moody’s, in their December base forecast shows no recession in the next eight quarters. And then the S3, the Moody’s S3 has a decline. Well, that has – that’s basically the modest recession forecast. So, that has three quarters of negative GDP. Maximum decline is 3.6% in Q2 this year and unemployment goes up to 7.8% in Q1 2024 and declined to 7.3% in Q4 2024. So, what we did is we were – since we adopted CECL, we were at this 30%, 40%, 40% – sorry, 30%, 40%, 30%. So, this quarter, we changed that to where the moderate recession is now, 55% of our CECL calculation. And the base is 35%, and the optimistic is 10%. So, we think for 2023, we are expecting 3% to 5% loan growth, primarily single-family residential, which requires very little reserving, about 30 basis points for us. That our provision for 2023 would be basically net charge-offs, plus a modest amount for loan growth. A couple of follow-up questions. In terms of the CD specialty running for the Chinese New Year, $600 million of new funds, as you mentioned, Heng. Should we assume that, that is – that you largely pay down the FHLB borrowings that you had as of 12/31? No. We – I think you said, it might have been poorly worded. But we are assuming 25 basis points on February 1, 25 basis points in mid-March. And we are not sure, there might be something in December in terms of a rate cut, but that would have a very minor impact. Okay. No, that’s fine. I thought I heard you say 75 basis points, so I kind of may have misheard. So, if you combine the ability to pay down FHLB, the benefit of the hikes in the first quarter and the interest recovery, it would seem to suggest that the first quarter is kind of peak NIM and then you maybe stay in that range for the full year but trend lower from there. Is that the way that you would expect the year set up? Okay. And then I saw you took the loss on sale of securities. Did you reinvest that? And if so, what was the yield pickup and – well, the yield pickup of those – that reinvestment? Actually, we had no losses. That was a mark-to-market for equity securities. But we – in the fourth quarter, we had pretty light investing. I think we bought $75 million of corporates. They were in the 5.5% range, callable corporates. And then we bought some MDS, they were in the high-4s. Okay. Thanks for that interpretation. I think I must have misread that in your press release. And then last question I had in terms of capital. And you kind of read through the kind of where capital is at year end, you did buy some stock back, but less than you did in the third quarter. Just thoughts about buyback in 2023. Is there any element of kind of economic uncertainty that might keep you on the sidelines, or would you still be a buyer of your stock in ‘23? Yes. We still have about $15 million – $16 million left in our buyback – current buyback authorization. So, we would use that up in the first quarter and then our plan is to get Fed approval – apply for approval for another $125 million. And given the relatively weak loan growth, we might – subject to economic conditions, we might try to use up most of that in 2023. If I could maybe start on just the expenses, the guidance for 3.5% expense growth in 2023. It feels like that might be a bit light versus kind of over hearing across the industry, just given inflationary impacts. So, I was hoping you could speak to maybe just some of the puts and takes as we think about expenses through 2023 and kind of the progression of the quarterly expense base. Andrew, we have gone through already half price significantly more than half of our population during the last October’s review process. So, that’s why you saw some of the core non-interest expense increase in the salary section at the Q4 numbers. And then we have a second round of the officers and higher reviews that will come up in March, and our objective is to hold that number to the 3.5% range. Understand. Okay. And then maybe if I could go back to the margin, just thinking about the – I know you had the spot rate on the deposit cost at the end of the quarter. Do you happen to have the spot yield on the securities portfolio at the end of the quarter? Not on the securities. We have it on the loans, if you wanted. Well, on the securities, I have the December securities, it’s 2.72%. Okay. That works. And then I think I just want to make sure I heard it correctly. The – so like the new kind of offering rate on CDs is around low kind of 4% territory, 4.2% or so. I guess just thinking about the duration of the CD book, should we expect CD costs to, kind of over the next 12 months or throughout 2023, kind of fully re-priced to that low 4% territory? Hopefully not. I mean the – this is the promotional rate program. And part of it is you have to bring – if it’s a $100,000 CD, you have to bring half – at least half of it. It has to be non-Cafe funds. So, outside of a normal promotion environment, I think we will be in the mid-3s for CD renewals for retail depositors. So, for large corporate depositors, we are higher than 4.2%, but that’s the market, and we have been doing that in the fourth quarter. There are no further questions at this time. Thank you for your participation. I will now turn the call back over to Cathay General Bancorp’s management for closing remarks. I want to thank everyone for joining us on our call and we look forward to speaking with you at our next quarterly earnings release call. Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.
EarningCall_1436
Good morning, ladies and gentlemen, thank you for standing by. Welcome to Saratoga Investment Corp.'s Fiscal Third Quarter 2023 Financial Results Conference Call. Please note that today's call is being recorded. During today's presentation, all parties will be in a listen-only mode. Following management's prepared remarks, we will open the line for questions. At this time, I would like to turn the call over to Saratoga Investment Corp.'s Chief Financial and Compliance Officer, Mr. Henri Steenkamp. Sir, please go ahead. Thank you. I would like to welcome everyone to Saratoga Investment Corp.'s fiscal third quarter 2023 earnings conference call. Today's conference call includes forward-looking statements and projections. We ask you to refer to our most recent filings with the SEC for important factors that could cause actual results to differ materially from these forward-looking statements and projections. We do not undertake to update our forward-looking statements unless required to do so by law. Today, we will be referencing a presentation during our call. You can find our fiscal third quarter 2023 shareholder presentation in the Events and Presentations section of our Investor Relations website. A link to our IR page is in the earnings press release distributed last night. A replay of this conference call will also be available. Please refer to our earnings press release for details. I would now like to turn the call over to our Chairman and Chief Executive Officer, Christian Oberbeck, who will be making a few introductory remarks. Saratoga's 33% sequential quarterly increase in adjusted net investment income per share substantially outpaced its recent record 26% dividend increase, as rising interest rates positively impact the company's largely floating rate assets and drive increasing spread margin due to Saratoga's largely fixed rate liabilities. Saratoga's credit structure with interest-only covenant-free long-duration debt incorporating maturities two to 10 years out, positions us well for rising and "higher for longer" interest-rate environment. Importantly, overall portfolio quality continues to remain high as demonstrated by NAV per share remaining essentially flat over the prior quarter. In this challenging capital markets environment, access to capital for growth is critical and we successfully recently raised more than $100 million in two baby bond offerings, maintaining our BBB+ investment-grade rating and received an important third SBIC license. In addition to providing liquidity for continued growth, these debt offerings further improve Saratoga's credit structure by extending its maturities five to 10 years out. Our existing portfolio companies are generally performing well with our overall fair value close to cost and our current business development pipeline strong. Our AUM continue to grow this quarter to $982 million as we originated $88 million of new follow-on investments offset by $57 million of repayments. We continue to be highly discerning in terms of new commitments in the current environment. Our pipeline remains robust with many actionable opportunities and we executed 18 follow-on investments exclusively in existing portfolio companies with strong business models and balance sheets which are well known to us. Our NAV per share this quarter was essentially flat with a 0.1% decrease from Q2 to $28.25, with headwinds from our CLO exposure in the broadly syndicated loan market almost completely offset by the positive financial performance of our core BDC portfolio and the over-earning of our Q2 dividend. This quarter's approval for our third SBIC license allows us to continue to expand upon our existing investments in support of the SBA's mission to provide growth capital to small businesses, which are so important to our economy. Our SBA guaranteed debentures are great benefit to our capital structure, further enabling us to provide innovative and cost-effective solutions to the many smaller and middle-market companies we finance. From an earnings perspective, we are reaping benefits from interest rate increases with 98% of our interest-earning portfolio at floating rates, and 96% of our borrowings at fixed rates. Our adjusted net investment income yield of 10.8% reflects a robust 32% increase over the prior quarter's 8.2%, consistent with LIBOR and SOFR trends. The average LIBOR base rate utilized for our portfolio for interest rate receipts and accruals during the quarter was 3.59%. Quarter-end LIBOR was 33% higher and 4.78%, implying that the entire impact of the current rising rate environment is not yet fully reflected in our reported earnings. To briefly recap the past quarter on Slide 2. First, we continue to strengthen our financial foundation in Q3, by maintaining a high level of investment credit quality with 96% of our loan investments retaining our highest credit rating at quarter-end and still only one investment on non-accrual, generating a return on equity of 4% on a trailing 12 month basis versus the industry average of 3.1%, recognizing $3.2 million net unrealized depreciation primarily reflecting broadly syndicated loan market volatility in the CLO and JV, offset by the core BDC portfolio appreciating by $2.6 million, and registering a gross unlevered IRR of 11.2% on our total unrealized portfolio and a gross unlevered IRR of 16.4% on total realizations of $879 million. Second, our assets under management increased to $982 million this quarter, a 3% increase from $955 million as of last quarter, a 20% increase from $818 million since year-end and a 48% increase from $662 million as at the same time last year. Our new originations were exclusively in 18 follow-on investments in our existing portfolio companies and our current pipeline remains robust. Third, in volatile economic conditions such as we are currently experiencing, balance sheet strength, liquidity and NAV preservation remain paramount for us. Our capital structure at quarter-end was strong, $336 million of mark-to-market equity supporting $459 million of long-term covenant-free non-SBIC debt, $243 million of long-term covenant-free SBIC debentures and $25 million of long-term revolving borrowings. Our total committed undrawn lending commitments outstanding to existing portfolio companies are $19 million. Our debt maturity schedule ranges from two to 10 years out, providing a solid credit structure at fixed cost, positioning us well in a rising rate environment. Further expanding our liquidity base, we issued $46 million of new baby bonds in October, followed by another $60 million of new baby bonds in December subsequent to quarter-end, both including the fully executed green shoes signaling maximum issuance demand, five year maturities callable after two years and trading under the tickers SAJ and SAY respectively. Our quarter end regulatory leverage of 173% has significant cushion over our 150% requirement. And prior to the $60 million new baby bond issued after quarter-end, we had a $179 million of investment capacity available to support our portfolio companies with $107 million available through our newly approved SBIC III Fund and $47 million in cash. Finally, based on our overall performance and liquidity, the Board of Directors declared a quarterly dividend of $0.68 per share for the quarter ended November 30, 2022, an increase of a record $0.14 or 26% from last quarter and our largest quarterly dividend ever, which was paid on January 4, 2023. Saratoga Investment's third quarter demonstrated solid performance within our key performance indicators as compared to the quarters ended November 30, 2021, and August 31, 2022. Our NII is $9.1 million this quarter, up 50% from last year and up 31% from last quarter. Our adjusted NII per share is $0.77 this quarter, up 45% from $0.53 last year and up 33% from $0.58 last quarter. Latest 12 months return on equity is 4%, down from 14.6% last year and 4.8% last quarter, and our NAV per share is $28.25, down 3.2% from 2.17% to $29.17 last year and down 0.1% from $28.27 last quarter. Henri will provide more detail later. As you can see on Slide 3, our assets under management have steadily and consistently risen since we took over the BDC 12 years ago and the quality of our credits remains high with only one credit currently on non-accrual, the same as last quarter. Our management team is working diligently to continue this positive trend as we deploy our available capital into our growing pipeline, while at the same time being appropriately cautious in this volatile and evolving credit environment. With that, I would like to now turn the call back over to Henri to review our financial results, as well as the composition and performance of our portfolio. Slide 4 highlights our key performance metrics for the fiscal third quarter ended November 30, 2022. When adjusting for the incentive fee accrual related to net capital gains, adjusted NII of $9.1 million was up 31.1% from last quarter and up 49.8% from last year's Q3. Adjusted NII per share was $0.77, up $0.19 from $0.58 per share last quarter and up $0.24 from $0.53 per share last year. Across the three quarters, weighted average common shares outstanding were 11.9 million for this year's Q3, 12.0 million for last quarter and 11.5 million for last year's Q3. There was zero accretion or dilution due to share repurchases and DRIP plans this quarter. Adjusted NII increased significantly as compared with last year with a 59.1% increase in investment income resulting primarily from a 48.4% increase in AUM and the increase in the current coupon on non-CLO BDC investments from 9.9% to 11.7%, partially offset by increased base management fees and interest expense resulting from the various new Notes Payable and SBA debentures issued during the past year and quarter. The full benefit of higher rates on AUM is not yet fully reflected in interest income. Sequential quarter changes reflect the same factors as year-over-year. However, the increase in current coupon is greater being from 8.8% to 11.7%. Adjusted NII yield was 10.8%, this yield is up from 8.2% last quarter and 7.3% last year. For the third quarter, we experienced a net loss on investments of $3.9 million or $0.32 per weighted average share, resulting in a total increase in net assets from operations of $6.0 million or $0.51 per share. The $3.9 million net loss on investments was comprised of $0.7 million in net realized loss on investments, $3.2 million in net unrealized depreciation on investments, and $0.4 million of deferred tax expense on unrealized depreciation on equity investments held in our tax blockers. This was offset by $0.5 million income tax benefit from realized gains on investments. The $0.7 million net realized loss on investments represents a $1.1 million realized loss on the sale of the company's Targus Holdings investment which is a legacy investment that was originated prior to Saratoga taking on the management of this company, offset by $0.4 million realized gain on the sale of the company's Ohio Medical equity investment. The $3.2 million net unrealized depreciation primarily reflects, one, the $5.8 million unrealized depreciation on the company's CLO and JV equity investments, reflecting the volatility in the broadly syndicated loan market as of quarter-end, and two, the $2.6 million unrealized depreciation on the company's Pepper Palace investments primarily reflecting company performance. These decreases were then offset by, one, a $1.5 million unrealized appreciation on the company's Vector Controls investment, two, approximately $1.0 million unrealized appreciation on both the company's Modern Campus and Hematerra investments, and three, approximately $1.8 million net unrealized appreciation across the remainder of the portfolio. All of the above appreciations primarily reflecting company performance. Return on equity remains an important performance indicator for us, which includes both realized and unrealized gains. Our return on equity was 4.0% for the last 12 months, beating the industry average of 3.1% despite the depreciations from our CLO and JV broadly syndicated loan investments discussed previously. Total expenses for Q3 excluding interest and debt financing expenses, base management fees and incentive fees and income and excise taxes was $2.1 million as compared to $1.2 million for last year and $1.6 million for last quarter. This represented 0.8% of average total assets on an annualized basis, up from 0.6% last year and unchanged from last quarter. Also, we have again added the KPI Slides 27 through 30 in the appendix at the end of the presentation that shows our income statement and balance sheet metrics for the past nine quarters and the upward trends we have maintained. Of particular note remains Slide 30, highlighting how our net interest margin run rate has continued to increase and is more than quadrupled since Saratoga took over management of the BDC and also increased by 20% the last 12 months, while still not yet receiving the full period benefit of putting to work the significant amount of Q3 cash nor the full impact of the currently rising rate environment. Moving on to Slide 5, NAV was $335.8 million as of this quarter-end, a $1.4 million decrease from last quarter and a $6.8 million decrease from the same quarter last year. In Q3, main drivers were $3.9 million of net realized losses and unrealized depreciation and $6.4 million of dividends declared that were partially offset by $9.9 million of net investment income. In addition, during Q3, $1.2 million of stock dividend distributions were made through the company's DRIP plan offset by $2.2 million of shares repurchased at an average price of $23.17. NAV per share was $28.25 as of quarter-end, down from $29.17, 12 months ago and $28.27 last quarter. This chart also includes our historical NAV per share, which highlights our NAV per share has increased 15 of the past 19 quarters. Over the long-term, our net asset value has steadily increased since 2011 and this growth has been accretive as demonstrated by the consistent increase in NAV per share. We continue to benefit from our history of consistent realized and unrealized gains. On Slide 6, you will see a simple reconciliation of the major changes in NII and NAV per share on a sequential quarterly basis. Starting at the top, adjusted NII per share increased to $0.77 per share, a $0.24 increase in non-CLO net interest income from the partial impact of higher AUM and higher rates and $0.01 increase in other income was offset by a $0.01 decrease in CLO net interest income, a $0.01 increase in base management fees and a $0.04 increase in operating expenses. Moving on to the lower half of the slide, this reconciles the $0.02 NAV per share decrease for the quarter. $0.83 of GAAP NII and $0.02 net accretion from share repurchases and DRIP was offset by $0.33 of net realized losses and unrealized depreciation and the $0.54 dividend paid in Q3. Slide 7 outlines the dry powder available to us as of quarter-end, which totaled $179.3 million. This was spread between our available cash, undrawn SBA debentures and undrawn secured credit facility. This quarter-end level of available liquidity allows us to grow our assets by an additional 18% without the need for external financing with $47 million of pro-forma quarter-end cash available and that's fully accretive to NII when deployed, and $107 million of available SBA debentures with its low-cost pricing also very accretive. The $107 million is available as a result of the receipt of our third SBIC license approved this quarter. In December, we also issued a new 8.125% 2027 baby bond, generating net proceeds of $58.1 million, which is in addition to the above available liquidity. This new baby bond is trading under the ticker SAY. We remain pleased with our available liquidity and leverage position, including our access to diverse sources of both public and private liquidity and especially taking into account the overall conservative nature of our balance sheet, the fact that almost all our debt is long term in nature with no non-SBIC debt maturing within the next 2.5 years. And importantly, that almost all our debt is fixed rate in this rising rate environment. We will talk more about this later. Also, our debt is structured in such a way that we have no BDC covenants that can be stressed and with available call options in the next two years on the debt with higher coupons, which is very important during such volatile times. Now I would like to move on to Slides 8 through 12 and review the composition and yield of our investment portfolio. Slide 8 highlights, we now have $982 million of AUM at fair value or $986 million at cost invested in 50 portfolio companies, one CLO fund and one joint venture. Our first lien percentage is 82% of our total investments, of which 25% is in first lien last out positions. On Slide 9, you can see how the yield on our core BDC assets, excluding our CLO, has changed over time, especially the past quarter. After an extended period of low rates and tightening spreads, we are seeing both these trends reverse. We have already seen some benefit in Q3 with our core BDC portfolio yield increasing from 9.9% last quarter and 8.8% last year to 11.7% this quarter and total yield increasing from 9.0% last quarter to 10.4% in Q3, but the full impact of the rising rate environment through today is still not yet reflected in our earnings. In addition, we have started seeing spreads widening as well with 98% of our interest-earning portfolio being variable rate. All of our investments being above their floors and rates continuing to rise significantly, we expect to benefit going forward from the earnings impact of rising rates to our NII, as you can see on the next slide. The CLO yield decreased from 8.9% to 7.4% quarter-on-quarter, reflecting current market performance. The CLO is performing and current. Slide 10 shows how at the end of Q3, the average three month LIBOR used in our portfolio was 359 basis points versus at quarter end when three month LIBOR closed at 478 basis points and versus today at approximately 475. With 98% of our interest-earning assets using variable rates earnings will benefit from this additional increase in Q4 and Q1 next year, while all but $25 million of our debt is fixed rate and will not be impacted by these increases in base rates. The increases in SOFR base rates are similar. And all indications are that rates could be rising further than this. As a result, we stand to continue to gain significantly as rates rise. That said, there will be a lag in the effect this dynamic has on our earnings due to timing of rate resets and invoicing terms. Slide 11 shows how our investments are diversified throughout the U.S. And on Slide 12, you can see the industry breadth and diversity that our portfolio represents. Our investments are spread over 39 distinct industries with a large focus on healthcare and education software, HVAC services and sales and IT, real estate, education, consumer and healthcare services, in addition to our investments in the CLO and JV, which are included as structured finance securities. Of our total investment portfolio, 9.6% consists of equity interest, which remain an important part of our overall investment strategy. For the past 11 fiscal years, we had a combined $81.5 million of net realized gains from the sale of equity interest. And two-thirds of these historical total gains were fully accretive to NAV due to the unused capital loss carryforwards that were carried over from when Saratoga took over management of the BDC. This consistent realized gain performance highlights our portfolio credit quality has helped grow our NAV and is reflected in our healthy long-term ROE. That concludes my financial and portfolio review. I will now turn the call over to Michael Grisius, our Chief Investment Officer, for an overview of the investment market. I'll take a few minutes to describe our perspective on the current state of the market and then comment on our current portfolio performance and investment strategy. Since our last update in October, we've observed the persistence of aggressive market conditions for premium credits with lenders remaining open for business and competing heavily for these high-quality opportunities. Liquidity remains abundant after the large-scale fundraisings of last year, but lenders are being more risk-sensitive backing off historically volatile sectors and taking a harder stance on the use of capital. Leverage levels remain elevated but where we are seeing movement is on the rate side, as Henri mentioned a couple of slides ago. Absolute yields are growing significantly as LIBOR and SOFR increased almost 170 basis points this past fiscal quarter, although they have moderated slightly in December. In addition, spreads are continuing to widen the lower middle market, where up until recently, it had mainly been happening in the broader syndicated loan and capital markets. In the first half of calendar year 2022, we saw high transaction volumes and M&A activity, albeit slightly lower than in 2021. In the second half of the calendar year 2022, deal volumes remained reasonably healthy in our market despite lower macro volumes. As a result, we continue to enjoy an actionable deal pipeline. In a competitive market, investors continue to differentiate themselves in other ways, such as accelerated timing to close and looser covenant restriction. That said, lenders in our market remain wary of thinly capitalized deals and for the most part, are staying disciplined in terms of minimum aggregate base levels of equity and requiring reasonable covenants, particularly given the concerns around a potential economic recession forecasted for some time in 2023. The Saratoga management team has successfully managed through a number of credit cycles and that experience has made us particularly aware of the importance of first being disciplined when making investment decisions; and second, being proactive in managing our portfolio. We're keeping a very watchful eye on how continued inflationary pressures and labor costs, supply chain issues, rising rates and slowing growth could affect both prospective and existing portfolio companies. A natural focus currently is on supporting our existing portfolio companies through follow-ons as was seen this quarter. We have confidence in our strong position entering a different credit and rate environment. Our underwriting bar remains high as usual, yet we continue to find opportunities to deploy capital as we will discuss shortly. Calendar year 2022 was a very strong deployment environment for us with a strong pace of originations. Follow-on investments in existing borrowers with strong business models and balance sheets continue to be an important avenue of capital deployment as demonstrated with 47 follow-ons in the last 12 months ending December 31 and 12 in the last calendar quarter alone, including delayed draws. In addition, we have invested in nine new platform investments this past calendar year with 15 total investments in these new companies during the year. Portfolio management continues to be a critically important aspect for us, and we remain actively engaged with our portfolio companies and in close contact with our management teams especially in this volatile market environment. All of our loans in our portfolio are paying according to their payment terms, except for our Nolan investment that we put on nonaccrual this quarter, as we work with the company on an agreement that will likely have us pick our interest for a period of time. Nolan is our only nonaccrual investment across our portfolio. To recognizing the unrealized depreciation from spread widening and performance on our overall portfolio this quarter, Saratoga's overall assets are now just 0.5% below cost basis. We believe this strong performance reflects certain attributes of our portfolio that bolster its overall durability. 82% of our portfolio is in first lien debt and generally supported by strong enterprise values in industries that have historically performed well in stressed situations. We have no direct energy or commodities exposure. In addition, the majority of our portfolio is comprised of businesses that produce a high degree of recurring revenue and have historically demonstrated strong revenue retention. Our approach has always been to stay focused on the quality of our underwriting. And as you can see on Slide 14, this approach has resulted in our portfolio performance being at the top of the BDC space with respect to net realized gains as a percentage of portfolio at cost. We are number two on a list of only 11 BDC's that have had a positive number over the past three years. This strong underwriting culture remains paramount at Saratoga. We approach each investment working directly with management and ownership to thoroughly assess the long-term strength of the company and its business model. We endeavor to peer as deeply as possible into a business in order to understand accurately its underlying strengths and characteristics. We always have sought durable businesses, invest capital with the objective of producing the best risk-adjusted and accretive returns for our shareholders over the long term. Our internal credit quality rating reflects the impact of current market volatility and shows 96% of our portfolio at our highest credit rating as of quarter end. Part of our strategy is to selectively co-invest in the equity of our portfolio companies when we're given that opportunity and when we believe in the equity upside potential. This equity co-investment strategy has not only served as yield protection for our portfolio, but also meaningfully augmented our overall portfolio returns as demonstrated on this slide and the previous one, and we intend to continue that strategy. Looking at leverage on Slide 15, you can see that industry debt multiples remained relatively unchanged for calendar Q2 to Q3 at historically high levels. Total leverage for our overall portfolio was 4.19x excluding Nolan and Pepper Palace, while the industry is now well above 5x leverage. Through past volatility, we have been able to maintain a relatively modest risk profile throughout. Although we never consider leverage in isolation, rather focusing on investing in credits with attractive risk return profiles and exceptionally strong business models, where we are confident the enterprise value of the businesses will sustainably exceed the last dollar of our investment. In addition, this slide illustrates the strength of our deal flow and our consistent ability to generate new investments over the long term, despite ever-changing and increasingly competitive market dynamics. During the fourth quarter -- fourth calendar quarter, we added no new portfolio companies but made 15 follow-on investments, increasing our 12-month production to 62 total new investments versus 47 for the same time period last year. Despite the success we're having investing in highly attractive businesses and growing our portfolio, it is important to emphasize that, as always, we're not aiming to grow simply for growth's sake. In the face of this uncertain macro environment, we're keenly focused on investing in durable businesses with limited exposure to inflationary and cyclical pressures. Our capital deployment bar is always high and is conditioned upon healthy confidence that each incremental investment will be accretive to our shareholders. Moving on to Slide 16, our team's skill set, experience and relationships continue to mature, and our significant focus on business development has led to multiple new strategic relationships that have become sources for new deals. Our top line number of deal source remains robust, but has dropped in the past two years, initially due to COVID, but more recently reflecting our efforts to focus on attracting a higher percentage of quality opportunities. Most notably, the number of deals executed during the last 12 months is markedly up from last year's pace, demonstrating that this more focused sourcing strategy is yielding results. What is especially pleasing to us is that four of the nine new portfolio companies over the past 12 months are from newly formed relationships, reflecting notable progress as we expand our business development efforts. As you can see on Slide 17, our overall portfolio credit quality remains solid. The gross unleveraged IRR unrealized investments made by the Saratoga Investment management team is 16.4% on $879 million of realizations. On the chart on the right, you can see the total gross unlevered IRR on our $936 million of combined weighted SBIC and BDC unrealized investments is 11.2% since Saratoga took over management. As of this quarter, we continue to have two yellow rated investments still only being our Nolan Group and Pepper Palace investments. Nolan has been yellow for a while now since COVID being more dependent on in-person business interaction and was also added to nonaccrual status earlier this year. The current unrealized depreciation reflects the current performance of the company, but does not change our view of the fundamental long-term prospects for the business. The other yellow investment is Pepper Palace. In this quarter, we recognized another $2.6 million of unrealized depreciation on this investment, increasing the total depreciation to $10 million since investment on our first lien term loan and preferred equity investments. Now this markdown reflects the current performance of the company, but they continue to pay interest. We are working closely with the company and the sponsor as they work to improve performance. Our overall investment approach has yielded exceptional realized returns and recovery of our invested capital. Moving on to Slide 18. You can see our first and second SBIC licenses are fully funded and deployed with $10 million of cash available for distribution to the BDC in SBIC II. We are also pleased to have received approval for our third SBIC license this quarter, which means we practically have access to another $107 million of low-cost SBIC debentures currently allowing us to continue to support U.S. small businesses. To summarize this quarter, the way the portfolio has proven itself to be both durable and resilient against the impact of COVID-19 and the subsequent calendar 2022 market adjustments and volatility really underscores the strength of our team, platform and portfolio and our overall underwriting and due diligence procedures. Credit quality remains our primary focus and new investments have a higher bar, especially at times with such increased activity levels for premium credits as we are seeing now. And while the world is in continuous flux, we remain intensely focused on preserving asset value and remain confident in our team and the future for Saratoga. Turning to Slide 19. As outlined, our latest dividend of $0.68 per share for the quarter ended November 30, 2022, was paid on January 4, 2023. A 26% increase, this is the largest quarterly dividend increase in our history. The Board of Directors will continue to evaluate the dividend level on at least a quarterly basis, considering both company and general economic factors, including the near-term impact of rising base rates and increased spreads on our earnings. Moving to Slide 20. Our total return for the last 12 months, which includes both capital appreciation and dividends, has generated total returns of negative 2%, outperforming the BDC index of negative 6% for the same period. This performance reflects the current market volatility impacting both us and the industry. Our longer-term performance is outlined on our next slide. Our three and five year returns place us in the top quartile of all BDCs for both time horizons. Over the past three years, our 27% return exceeded the index average of return of 12%. Over the past five years, our 71% turn more than double the index average of 35%. When Saratoga took over the management of the BDC in 2010, our total return has been 626%, versus the industries of 171%. On Slide 22, you can further see our performance placed in the context of the broader industry and specific to certain key performance metrics. We continue to focus on our long-term metrics such as return on equity, net asset value per share, NII yield and dividend growth, which reflects the growing value our shareholders are receiving. Notwithstanding the slight decline of 0.1% in NAV this quarter, we continue to be one of the few BDCs to have grown NAV over the long term, and we have done it accretively by also growing NAV per share, 15 of the last 19 quarters. Moving on to Slide 23. All of our initiatives discussed on this call are designed to make Saratoga Investment a leading BDC, and is attractive to the capital markets community. We believe that our differentiated performance characteristics outlined on this slide will help drive the size and quality of our investor base, including adding more institutions. Our differentiating characteristics include maintaining one of the highest levels of management ownership in the industry at 14%. Access to cost-effective and long-term liquidity with which to support our portfolio and make accretive investments recently demonstrated with our SBIC III license approval this quarter and new baby bond raised in December, a BBB+ investment grade rating in active public and private bond issuances, solid historic earnings per share and NII yield benefiting from the rising rate environment, with 98% of our credit AUM floating rate, while 96% of our debt is fixed rate. Strong and industry-leading long-term return on equity accompanied by growing NAV and NAV per share, putting us to the top of the industry over the long term, high-quality expansion of AUM and an attractive risk reward profile. In addition, our historically high credit quality portfolio contains a minimum exposure to conventionally cyclical industries, including the oil and gas industry. In closing, I would like to refer to Slide 10 that Henri walked you through earlier in the presentation. In this rising rate environment, Saratoga is a beneficiary of increased short-term LIBOR and SOFR interest rates. In Q3, Saratoga's average three-month LIBOR used for interest rate income purposes was 3.59%. At November quarter end, the closing LIBOR rate was 119 basis points or 33% higher at 4.78%, with the spot rate today at a similar level, implying that the entire impact of today's rate levels is not fully reflected in this quarter's reported earnings. We remain confident that our reputation, experienced management team, historically strong underwriting standards and time and market tested investment strategy will serve us well in navigating through the challenges and uncovering opportunities in the current and future environment. And that our balance sheet, capital structure and liquidity will benefit Saratoga's shareholders in the near and long term. In closing, I would again like to thank all of our shareholders for their ongoing support. And I would like to now open the call for questions. Thank you very much. Good morning. I appreciate you taking the question here. I wanted to kind of ask about the dividend. Obviously, great to see the increased dividend and certainly good to see that it followed a nice increase in earnings. Maybe Chris and Henri, Mike, can you speak to how you're thinking about the dividend constructs we've seen other BDCs take an approach, a variable approach where you're paying a base and then a supplemental on top of the base based on kind of excess earnings. So -- and that with the context of the rate environment and the potential for rates to eventually go back down at some point. So just trying to understand how you all are thinking about that dividend and the dividend construct and giving any consideration to a base plus supplemental construct? Thanks. Sure. Well, I mean, that's a very good question and something that we have thought a lot about. I think if you look at our earnings level in this recent quarter, while substantially up, the base rate of LIBOR that they're based on is actually substantially lower than the market rate is at this time. And then if you look at the forward curves and who knows, how right the market is, but the rates go up next year and then they're projected to come back down in 2024. But they're projected to come back down in 2024 kind of not that far off of where our average rate is in this most recent quarter. So we feel at this point in time that we are well positioned with our core dividend rate that we can sustain this over certainly the long run. With that said, rates -- I don't know exactly how much higher they may go from where they are now, we are currently over-earning our dividend by a substantial amount. We may continue to do that. We're in a very good position relative to our spillover. So we have room, too over-earned should that be something that made sense for the shareholders. And so we've got to kind of see how this plays out. If it looks like the interest rates are going to stay up for quite a while, then we can move, obviously, our core dividend. If we think it's going to be relatively more temporary, we could consider that sort of bifurcated mode that some of our others have done. So -- but all of this is sort of to be seen and to be determined because this rate environment, there's just a tremendous amount of uncertainty as to exactly how it plays out. But I think the most important consideration is that we feel that the current level we're at is sustainable for the long run. And we will look to build upon that as our earnings increase and as the rate environment becomes more clear. Great. That's good color, Chris. Maybe a follow-up question around rates and the impact on your borrowers. Can you speak to how borrowers are reacting to the higher rates. Obviously, it's the same for all borrowers expecting with the floating rate debt, but just kind of curious how borrowers are reacting to the higher debt service. And it looks like from a fair value mark perspective, most are performing really well. But any color around borrowers and reaction to debt service would be great. Thanks. Bryce, this is Mike. That's a really good question. We feel good about our portfolio construction in terms of interest rate coverage. While most of these deals are reasonably leveraged, we spent a lot of time looking at and trying to seek out businesses that have not only really solid dependable cash flow but really strong cash flow margins. So they're generally businesses that can withstand some increase in rates and still produce plenty of excess cash flow with which to comfortably service our debt. So when we look at the interest coverage that we have across our portfolio, there's healthy room there to support the interest coverage in terms of how people react to it. Yes, they don't like to see rates up, but it's kind of the market environment. So anybody else that they're talking to about borrowing money, it's kind of they're facing the same thing. So it's a little bit of it is what it is, but the important thing, I think, is that our portfolio companies are demonstrating that they continue to perform well and are producing sufficient excess cash flow to handle the increase in rates that we've experienced. If I could just add in terms of the new deals, which are kind of -- everybody who's got what they have, they have what they have. But we're looking at a lot of new opportunities, and we're pricing in the new level of debt and companies and sponsors are happy to have it, happy to -- I think we're seeing quite a robust pipeline that it seems like the -- if there's a balance of power, if you will, between borrowers and lenders, I think for the last few years, the borrowers seem to have relatively more leverage in negotiations. And I think that balance is moving the other way, how far it is, it depends on the market, depends on the deal, depends on the sponsor. But we are seeing improvement in overall competitive dynamic and negotiating leverage. And as part of that, the rate structure that we're seeing is being accepted for new deals. No, it's a good point, Chris. I mean I should have emphasized that. So one development that certainly we're seeing, especially in this last quarter and in the environment that we're in now is Bryce, is that spreads are widening as well. So just in terms of receptivity to a higher rate environment, not only are new borrowers seeing higher indexes but we're able to get wider pricing now than we were even a few months ago. So we're finally starting to see that in our market as well. So if there's an indication of sort of the reaction to rates. Now I do think the higher rate environment is affecting M&A activity in general. So there may be in the broader market fewer deals just in general because of kind of the macro environment. But for the deals that we are seeing, which are high-quality deals and kind of the micro market that we occupy at the lower end of the middle market, we're seeing plenty of activity. And for those deals that we're seeing, they're expecting higher rates, and we're getting them. Thank you. [Operator Instructions] Our next question will come from Casey Alexander of Compass Point Research & Trading. Your line is open. Hi, good morning. I think this quarter really highlights the underappreciated power - earnings power that you guys have many BDCs are exhibiting right now, and I don't think the market is really appreciating it. And if it weren't for spread widening, your NAV actually would have been up $0.40 a share. So I think it's a very good, and I appreciate the commentary around the dividend because I think holding on to those excess earnings right now to allow NAV to build or to hold against potential credit issues is a great idea. With all those positives, I'm going to do my job and trying to find a couple of places to pick out here. One is looking at the new baby bond deal that you did in December, the absolute and regulatory leverage ratio is really quite high. Can you speak to those leverage ratios and to the extent to which you're comfortable -- I mean, I calculate a regulatory leverage ratio close to 1.5x when you factor in the new baby bond deal. Can you speak to those leverage ratios and why you can comfortably carry a leverage ratio that high? Sure. Maybe I'll start and then and Henri, you can fill in. Well, first of all, Casey, there's several components to anyone's leverage, right? And the character of the leverage is very, very important. And I think one of the things that we've always carried and the market sort of come around to make our structure work very well right now. And what we have in our leverage is we've got a long-term fixed rate, interest-only covenant-free debt, and our maturity schedule is two to 10 years out. So it's a long time from now before we have to repay any of our leverage. And the spreads off of the marketplace to our leverage are widening, both absolutely with the base rates and with spreads and in terms of our new deals coming on. So our profit margins are expanding, and our leverage structure is very solid. And then on the other side of it, of course, is portfolio. And so when we look at our portfolio and the character and the stability of our portfolio, we look at all that together, and we think we're very well positioned for really substantial earnings. And I think we've just demonstrated this past quarter. I think the earlier quarters in the year, there was a lot of things working through the system and LIBOR lags and adjustments and where our liabilities might have gone up a little higher -- the CLO might have gone up earlier than our asset base rates and all those types of things, but we're kind of through that period now. And so the incremental improvements are kind of flowing directly through to our bottom line. So we have a tremendous amount of earnings that we're generating against this leverage and the structure is extremely favorable. A further point picking up on what Bryce said earlier, there's a question as to whether we're going to see the same rates in two years or three years. And there's a possibility that as rates come up, then they come back down. But I think what's really important also about our leverage structure is -- and Henri correct me on the number, but I think almost two-thirds of our debt is callable in two years or less. And so we do have the ability to reconfigure this fixed rate structure of ours should rates decline. And so I think those are elements that give us comfort operating within the structure. Another part of the dynamic that we've been experiencing is, as Mike said earlier, there's been a slowdown in M&A as gaps between buyers and sellers, ability to finance, leverage all those things have come about. And one of the benefits that we have received as a result of that is a little slower repayments than we might have had before. And so we have this phenomenon of a lot of our high-quality loans are not getting refinanced, right? The only time we get paid off is generally with an M&A transaction and M&A transactions have slowed down. So our core portfolio is sticking with us longer than it had before. And then as our scale is improving and our relationships are broadening and that type of thing, we're getting a lot more new investments coming in. So there's kind of -- those two forces at work are allowing us to add very high-quality assets through our very high-quality asset portfolio right now with improving new relationships. And each of those as you can see, I mean, last quarter, we did 18 follow-on investments. So we have a very solid portfolio with good demand in credits that we know extraordinarily well. The other thing I would say, too, about the leverage is we have very long duration leverage, and we have essentially on a historic basis shorter duration assets. And so we think we're very well positioned, the way we're set up. And I think that the earnings flow that we're seeing is reflective of that. All right. Thank you. My next question is for Mike. Mike, looking at the fact that all of your new issuance in this quarter was follow-ons. I'm curious, do you have what you would call a higher bar for new investments than you have for follow-ons? And is it more important in this environment with what you see coming at you economically to make sure that you're more supportive of existing portfolio companies as opposed to new companies, which you don't have that history with? Really good question. And the answer, very succinctly is yes. We certainly, first and foremost, want to make sure that we've got capital available to support our existing portfolio companies. There's not a better call you can get in our industry than a call from a borrower who is performing really well. You know them really well. You like the ownership group, and they've got an opportunity to continue to grow their platform and they're looking for additional capital to put to work. So we did that very successfully this past quarter. It's a big part of what we do just institutionally, if you sort of look at the playbook that we operate under very often, we're making a bit smaller investment as we're getting to know a portfolio company. And then most of our deals and certainly almost all of our best deals have been ones that have started off small and have become much more sizable. Now having said that, we still are seeing good actionable opportunities. And it so happens that just this past quarter, we didn't get any that really -- or didn't find any that really met our underwriting bar. Some of that was due to the fact that we just have a really high standard to begin with. Are we thinking even harder now about businesses that -- what the outlook for a business could be if we were to go through an even a difficult economic time, yes, we are. And certainly, that's probably affecting our bar at the margin. But generally, we have a high bar to begin with. And I think most of the fact that we have fewer portfolio companies this past quarter is sort of reflective of just M&A activity being down. Now having said that, our business doesn't operate sort of like a switch. It just -- it's really hard to predict how these things work. Right now, our pipeline of new portfolio opportunities is quite full. We're seeing a lot of things that we think are really interesting. In fact, I'd add to it, Casey, while I'm on that topic, we've been doing this for a long time. Now is a great time to be investing in new portfolio companies. If you see a deal that's in market right now, first of all, it means it's performing well, and it's performing well in a market where the company is producing really solid cash flow growing, and it's doing that despite facing growing pressure from a cost standpoint and you get a chance to underwrite that with some of that kind of right in front of you. You also get a chance to underwrite it and lend capital with better pricing and less competition than what we've seen just six months ago. So it is a really nice time to be investing capital. For those deals that meet those standards that are probably slightly higher than what they usually are, and they're already -- the standards are already really high to begin with. Hi, guys. And congratulations on the quarter. One sort of a follow-up to Casey actually. On follow-on investments being a greater portion of the mix. I mean all the credit and knowing the borrower I understand. So the other question though is when doing a follow-on, do you get the opportunity to put incremental equity into an investment where you've already got an equity investment? Or is it the equity goes in day 1, the follow-ons are debt only? I mean, just trying to get a feel of so much of your performance historically has been generating realized gains on equity, et cetera. If you shift on to follow-ons, are you at the margin losing a little bit of opportunity to keep equity at some portion of the portfolio that you want to target? Yes, it's an interesting question. So here's how we think about it. And the answer is that it depends. So in some cases when an existing borrower is looking for more capital to grow, the capital that they need requires both debt and equity. There's a portion that makes sense to fund with debt, but also we need to step up with additional equity. In those cases, we have co-investment rights for our equity, and we typically almost always participate and co-invest alongside the control owner. So when that happens, we're co-investing along the way. Now in other cases, they're looking for follow-on capital and the business is performing so well that when you look at the capital structure pro forma for whatever the growth initiative is, it may be an acquisition, it may just be growth to fuel growth in EBITDA. When you look at the capital structure, it may not need equity. But if you're already an existing equity investor, it's very accretive to the existing equity that you have. So that's still good news as well. So to the extent that we have an equity investment in an existing portfolio company, whether we're co-investing along the way or sitting on our current position or our initial position of equity, it typically benefits our initial equity investment very significantly and that's proven out well over time. Got it. Got it. Yes. I appreciate that color, and I appreciate the classic opening of it depends, which is always the case. On the dividend, I mean, I understand your comment on the earnings power is going to go up materially from here as we get into the middle of the year based on where the forward curve is, I understand retaining some to grow NAV, et cetera, but the BDC rules are what they are, right? So you can't just keep by the distribution requirements. And given an increased dividend but potential earnings power that -- not putting words in your mouth, but could get to like $1 per share kind of per quarter in future quarters. You're going to generate a lot of spillover income in a hurry. So what are your thoughts on how you would handle that if rates do stay higher for longer, that at some point, it's a good problem to have, but it becomes a problem if you build up too large a bucket on spillover, if there's a big earnings dividend missed. So can you give us your thoughts there? Sure. I think as you point out, I mean, I think these are the type of problems we like to work on. Absolutely, you're right. I mean there are hard rules. You have to -- you've got kind of a two-year period to pay all the -- pay out your high percentage of income from, and we have a certain spillover equation right now, which is fortunately not -- we've got a lot of room in it. And -- but ultimately, if our earnings do increase, as you outlined, that amount of spillover will increase. And then ultimately, all this has to be paid out to shareholders. So in the meantime, right, it would build NAV and so the shareholders are going to get it one way or the other, right? They're going to get either through NAV or through dividends along the way. I think the biggest issue, right, is what's going to happen next in our economy. I mean everybody knows we're in an inflection point to sort of an unprecedented environment, right? We're kind of in a higher for longer rising rate environment, inflation, all these type of things. No one has seen that for 40 years, experienced that systematically, consistently, you've got a very hawkish position from the Fed, which is more aggressive than the market. So there's just a lot of questions to what's this all going to look like. If we have sort of this rising rate environment, followed by massive cuts back down to a hyper stimulative environment, which is -- that's one scenario. I don't know what the odds of that scenario are. We have to be prepared for that. We don't want to get too far out on that and then you could have a difficult economy. And so all those are still questions. Right now, as you can see, we're up 26% on dividend and 33% on earnings. So that's not too big a problem for us right now. In another quarter, we'll see how that goes. As you know, from the embedded increased interest rates, right, there's some base increase built in just doing the math where interest rates were at the end of our quarter versus the average during the quarter. So all this is building. And -- but you look at the forward curves, I said there's a battle between them, is the Fed going to hold it like they say? Or is it going to come off like the market says. And I saw an interview with Larry Summers recently, and he said he thinks it's going to be relatively more towards the Fed than towards the market. And it's very hard to tell that. And so we're just going to have to make these decisions over time. And fortunately, we're in a very good position to make these decisions, right? I mean we have these increased earnings. We've got lots of spillover room, and we can watch and see. And I think in an earlier question from Bryce, I mean, there's an ability to do dividend payouts that aren't permanent and there's ways to do it that are permanent. And I think what we've been attempting to do is to give our shareholders confidence in a dividend level that they can depend on. And that's something that we're working to do to say, look, you can depend on this dividend and the excess is going to be going into NAV for a period of time, but you're going to benefit it from it one way or the other. Henri, do you want to add to that. Yes, Robert. And I think just the nice thing about the RIC rules and you know how they constructed is, it allows you to plan really well sort of looking ahead more longer term and to manage the payment and to manage the spillover. So as you mentioned, yes, as rates go up, our earnings, i.e., our taxable income that we need to distribute will increase quickly. But that doesn't mean that we will have to pay it out quickly based on the payment rules of the rig structure. So that allows us to sort of -- if you manage your spillover well, which we think we have. It allows you to really plan more long term how you want to pay it out, especially in an economic environment. As Chris was talking about, that is more uncertain. So although the accretion maybe happens quickly, the payment doesn't necessarily happen quickly, which is the nice thing about the sort of the planning mechanism of the RIC rules. One for the point -- I'm sorry, just one further point on this. And I think that we have been very careful. And I think as you may recall from our very, very long conference call in April of 2020, we've been very careful with our spillover. And we've used our spillover as sort of like a rainy day fund, if you will, or something like that. And some other BDCs are kind of max on their spillover. They view it as a source of capital, perhaps. And so they don't really have a lot of room. And if they have an increase, they kind of have to pay it out immediately. But we've created this flexibility for ourselves utilizable in this environment to give us the time to consider an optimal approach to sort of permanent dividends versus temporary dividends. And as we said before, we're trying to come up with a sustainable, dependable dividend rate and that our shareholders can expect and then look behind all this question and our thinking, right, is what levels of dividend increase are we going to have next quarter and the quarters and the quarters after that? And obviously, I think the balance of consideration is that's going to be relatively more available than in sequential quarters, certainly in the very near term than there has been in the past. Understood. I really appreciate the color and to your point you've managed spillover such that it's not going to force your hand by being near a cap. So that's a good spot to be in as well. So, thank you for the color. Thanks. Good morning. Most of my questions have been asked and answered at this point. And I guess the one I still have is a bit of a follow-up in some terms. So I guess thinking about the health of the borrowers in your current portfolio? And what could impact them certainly based on the outlook for the Fed funds curve, there's another 50 basis points, maybe 75 that would happened here at the beginning of the year in LIBOR would likely follow suit higher to a similar magnitude. There's also a concern about the trajectory of the economy and whether we dip into a mild recession or something more moderate or severe. As you think about the potential for credit and the health of your borrowers. At this point, what would be a larger risk if the Fed had to continue hiking further beyond current expectations, which would put a higher debt burden on your companies or material slowdown in the economy that would materially impact EBITDA and the cash flow of those companies. Just curious how you think about that and weigh those risk factors today? Well, let me try and answer it first from a high level, and then Mike can speak very specifically to our portfolio. So at a high level, we have the good fortune of investing in the smaller middle market. And so each of our companies has its own destiny, its own marketplace, its own universe. And a lot of these macro considerations, they kind of affect the broader economy in sort of broader ways and there's a lot of cyclicality in the economy. I mean we were just -- in our last investment meetings, we have one of our portfolio companies, we're actually talking about decreasing their rate because they're earning so much money, they want to pay us back, like no, don't do that. I mean they're having surging increase in revenues. And so -- the U.S. market is such a huge, huge place, and there's so many opportunities and efficiencies and all of the Software as a Service companies that we invest in they're creating efficiencies to their products. And so there's a growth dynamic that's going to persist even in a negative -- in a recession. I mean if we have a mild recession, it may not affect a lot of our companies really much at all. And if we have a severe recession, there's a bunch of our companies that will still continue to do well, can continue to do well. So I don't mean to paint an overly rosy picture of everything for everybody. But what I would say is that each of our companies is not necessarily as affected by these macro trends on a current basis and then it partly has to do with the nature of our portfolio and also they're the smaller companies. I mean if you're Walmart, if you're McDonald's, if you're Procter & Gamble, I mean they're much more exposed to the very broad gauge what's going on in the big economy. But our companies have very specific niches in very specific markets and market opportunities. When you add them all up, they aren't necessarily as correlated to the broader economy. Yes. Let me add to that a little bit, Chris, because it's a good question and an interesting observation you make. We spend a lot of time thinking about that at the front end when we're underwriting deals, and there's so many things that we think about. But first and foremost, at the end of the day, all of the work that we're doing is centered around trying to get a comfort level that the business that we're lending to is at a minimum going to be in a position where under almost all reasonable circumstances we feel comfortable they're going to sustain their cash flow level. And we do that by looking at the end markets that they're in. We look at the value proposition that they offer their customers. We try to think about all the vulnerabilities they may have in the future and reach an assessment as to whether they're going to be able to continue to offer that value proposition to the customer in a way that's very profitable for them. And that underwriting is the most important component to what we do. It makes us -- it draws us to certain industries. It draws us to industries that are less cyclical. It draws us to companies that have wide margins that produce lots of cash flow, why do they have wide margins because they can price their products at a level that allows them to have strong margins because people want their products, they see our services. They see the value in them. And the most important thing in the underwriting and the capital structure, therefore, tends to be the persistency of the cash flow. Now when we underwrite, and I should say before I move into the interest rate part of your question, when we underwrite as I said, we're thinking about all the downside scenarios, but the cash flow is -- and the persistency of that cash flow is the most important thing. As you get into another component that we look at, which is what is the capital structure, how much leverage is reasonable for the business relative to all the things I discussed that we think about in terms of the business fundamentals that factors in as well. And as we look at our portfolio, generally, and this is just true in credit in general, the businesses are going to be affected more if their cash flow were to go down much more than if their interest rates go up. So we construct our businesses and the capital structures that we lend to in a way where as I said, we, first and foremost, get comfortable that the cash flow is persistent and usually it's going to grow, that we feel comfortable it's going to grow quite considerably. But in the downside scenarios that we run, we're looking at things like interest rate sensitivity, et cetera. And while there's some effect that, that can have on free cash flow of the business, that has a much more marginal impact than the fundamentals of the business itself. We feel comfortable. I want to make this point that when we look at our portfolio construction right now that we are in really good businesses in really good end markets in companies that are well positioned to continue to offer that same value proposition that I mentioned to their customers in a way that will allow them to continue to be solidly profitable. Thank you. I see no further questions in the queue. I would now like to turn the conference back to Mr. Christian Oberbeck for closing remarks. I would like to thank all of you for joining us today, and we look forward to speaking with you next quarter.
EarningCall_1437
Welcome to Alico's Fourth Quarter and Full-Year 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. As a reminder, today's conference is being recorded. Earlier today, the Company issued a press release announcing its results for the fourth quarter and full-year ended September 30, 2022. If you have not had a chance to view the release, it is available on the Investor Relations portion of the Company's website at alicoinc.com. This call is being webcast, and a replay will be available on Alico's website as well. Before we begin, we would like to remind everyone that the prepared remarks today contain forward-looking statements. Such statements are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those expressed or implied in these statements. Important factors that could cause or contribute to such differences include the risk factors detailed in the Company's annual report on Form 10-K as well as its future quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments thereto filed with the SEC and those mentioned in the earnings release. The Company undertakes no obligation to subsequently update or revise the forward-looking statements made on today's call, except as required by the law. During this call, the Company will also discuss non-GAAP financial measures including EBITDA and adjusted EBITDA. For more details on these measures, please refer to the Company's press release issued earlier today. Thank you, Doug. Thank you, everyone, for joining us for Alico's fourth quarter and fiscal year ended September 30, 2022 earnings call this afternoon. Fiscal year 2022 was a challenging year for Alico. Two weather events had a meaningful impact on our company and the Florida citrus industry. As previously discussed, in January, the freeze increased fruit drop for our Valencia crop at the beginning of our harvesting season, and we made the decision to accelerate the harvest of the remaining fruit and that did not have time to mature to optimal quality standards. At the end of September, Hurricane Ian struck Southwestern Florida with 150-mile an hour winds. The slow-moving storm moved across the state, causing substantial fruit drop at the majority of our groves. Fortunately, tree damage was largely limited to only one property. This lost fruit impacted our fiscal year 2022 financial results through an aggregate of approximately $23 million of one-time items for casualty losses and inventory adjustments. Fiscal year 2023 will see lower levels of revenue because we have less fruit available for sale. Based upon our prior experience with storms of this nature, we anticipate it may take up to two seasons or more for our groves to recover to pre-hurricane production levels. I would point out, however, that after Hurricane Irma struck in 2017, our groves recovered the following harvest season. We maintain crop insurance and we are currently working closely with our insurers and adjusters to evaluate and determine the amount of insurance recovery we maybe entitled to, if any. For the fiscal year ended September 30, 2022, the company reported net income attributable to Alico common stockholders of approximately $12.5 million compared to net income attributable to Alico common stockholders of approximately $34.9 million for the fiscal year ended September 30, 2021. The fiscal year ended 2022 results were negatively impacted by approximately $23 million of one-time items for casualty losses and inventory adjustments related to the impact of Hurricane Ian. Our adjusted EBITDA which excludes non-recurring items, was approximately $13.4 million for the fiscal year ended September 30, 2022 as compared to approximately $25.3 million for fiscal year ended 2021. Our overall box production for fiscal year 2022 was approximately 5.5 million boxes, a decrease of 12.9% as compared to fiscal year 2021. Company believes that actions taken in recent years make our balance sheet one of our greatest strengths. Our long-term debt levels have been significantly reduced through prepayments and most of our term debt maturing in 2029 is now non-amortizing. Alico negotiated an extension of its $70 million working capital line of credit with Rabo Agrifinance, Inc. until November 1, 2025. Our $25 million revolving line of credit with MetLife extends until November 2029. We believe that these credit facilities provide Alico with ample liquidity while the company manages through the impact of the recent weather events. Senior managers of the company have been working closely with Florida Citrus Mutual, the industry trade group, and government agencies, to seek federal relief to aid our recovery from the effects of Hurricane Ian. Alico also took other significant actions throughout the fiscal year, such as the following. We repaid approximately $19.6 million of debt, which included a prepayment of approximately $15.6 million on our variable rate term loans. As of September 30, 2022, we have improved our debt-to-equity ratio to 0.45 to 1, it was 0.50 to 1 a year ago. And over the past six years, we reduced our debt balances by 45%, having made principal payments of approximately $91 million. Our current supply agreements of approximately 99% of the fruit committed to the 2023 harvest season. In 2017, we planted approximately 1.9 million new trees which has materially increased tree density in our existing and recently purchased groves. We believe our tree planting strategy over the last six years as the long-term potential to enable the new acres we now own to significantly increase box production over the coming years. We continue to evaluate our non-citrus assets and opportunistically sold off ranch land at prices we believe to be attractive to generate cash flow. During the fiscal year 2022, we closed on the sale of approximately 9,400 acres of ranch land, and we still have approximately 20,000 acres of ranch land for potential sale and we are seeing continued interest from potential buyers. Future capital allocation decisions will be evaluated in an effort to maximize returns to shareholders, which may include, but are not limited to, pursuing opportunities to acquire additional citrus acres at attractive prices, repurchasing common shares, making other acquisitions or even considering special dividends as asset sales such as additional portions of the Alico Ranch, are realized. Our environmental, social and governance initiatives continue and we just published our second annual sustainability report. As previously communicated, our Board formed an ESG committee, we launched a sustainability page on the company's corporate website, which includes our sustainability policy, our vendor code of conduct and our safety manual. We completed a materiality assessment that helped inform a sustainability framework to guide future ESG activities, and we joined the UN Global Compact to support universal sustainability principles of environmental responsibility, labor and human rights and anticorruption. Thank you, John, and good afternoon, everyone. As our fourth quarter is not indicative of our full-year results due to the seasonal nature of our business, I will focus primarily on the full-year fiscal 2022 results today. As a reminder, the majority of our citrus crop is harvested in the second and third quarters of the fiscal year, with the majority of our profit and cash flows also recognized in the second and third quarters. For the fiscal year ended September 30, 2022, total operating revenue was $91.9 million compared to $108.6 million for the fiscal year ended September 30, 2021. Citrus revenue was $89.7 million and $105.8 million for the fiscal years ended September 30, 2022 and 2021, respectively. The decrease in revenue for the fiscal year ended September 30, 2022, compared to the fiscal year ended September 30, 2021, was primarily due to a decrease in the revenue from lower box production particularly our Valencia fruit and a reduction in our Grove Management Services. The decrease in early and mid and Valencia fruit harvested was primarily driven by a decrease in process box production and a decrease in pound solids per box. As previously discussed, this was primarily due to the January 2022 freeze event, which increased fruit drop at the beginning of our Valencia harvesting season, and we made the decision to accelerate the harvest of the remaining fruit which did not have time to mature to optimal quality standards. Our average blended price per pound solid increased from $2.45 in the prior fiscal year to $2.63 for the current fiscal year. This was primarily due to tighter supplies of citrus fruit, which in turn led to reduced inventory levels at the juice processors. Largely offsetting this increase in pricing was the number of fewer Valencia boxes being harvested and lower pound solid per box for the fiscal year ended September 30, 2022, compared to the prior year, which resulted in lower revenues. We along with the entire Florida industry, in general, recorded a smaller number of boxes harvested as a result of greater fruit drop during the current harvest season as compared to the previous year. During the fiscal year 2022, we provided our Grove Management Services, which includes citrus grove caretaking and harvest and all management services to approximately 7,400 acres of land owned by third parties of approximately 7,000 acres, which are serviced under property management agreement, which was entered into in July 2020 with a top 10 grower. During the third quarter of 2022, the property management agreement covering these approximate 7,000 acres was terminated by the grove owner and all property management and caretaking services ceased as of June 10, 2022. As part of these agreements, we are reimbursed for all costs incurred relating to providing these services and receive a management fee based on acres coverage from the third parties. As a reminder, we recorded both an increase in revenues and expenses as and when we provide these services. For the fiscal year ended September 30, 2022, we recorded approximately $11.9 million worth of operating revenue from Grove Management Services as compared to $17 million in the fiscal year ended September 30, 2021. The terminated property management agreement represents $10.6 million in revenue in fiscal year ended 2022 as compared to $15.8 million in fiscal year ended 2021. The USDA in its final citrus crop forecast for the 2021/2022 harvest season, indicated that the Florida orange crop decreased by 22.5% to approximately 41.1 million boxes from approximately 53 million boxes in the prior harvest season. In comparison, we declined in the current harvest season by 12.9%. The increase in operating expenses for the fiscal year 2022 as compared to fiscal year 2021, mostly relates to the approximate $23 million in casualty loss and inventory adjustments as a result of Hurricane Ian. This increase was partially offset by a decrease in Grove Management Services and harvest and haul expenses. As previously stated, we entered into an agreement with the top 10 grower to provide property management and caretaking services covering approximately 7,000 acres. During the third quarter of 2022, the property management agreement covering these approximate 7,000 acres was terminated by the grove owner and all property and management and caretaking services ceased as of June 10, 2022. For the fiscal year ended 2022, we recorded approximately $10.5 million of operating expenses from Grove Management Services, as compared to approximately $15.1 million in the fiscal year ended September 30, 2021. The terminated property management agreement represented $9.7 million in operating expenses in the fiscal year ended 2022 as compared to $14.3 million in fiscal year ended 2021. We recognized lower harvest and haul expenses due to the lower box reduction previously discussed. General and administrative expenses for the fiscal year ended September 30, 2022, were approximately $10.1 million compared to approximately $9.5 million for the fiscal year ended September 30, 2021. Increase was primarily attributable to an increase in legal expenses as compared to fiscal year ended 2021 with the fiscal year 2021 legal expenses reduced by $700,000 reimbursement from insurers for a corporate legal matter from 2018. In addition of fiscal year ended 2022, the company recognized approximately $0.2 million in stock compensation expense for restricted stock awarded to non-executive employees. These increases were partially offset by a reduction in payroll expenses of approximately $0.3 million relating to a reduction in headcount from 222 on September 30, 2021, down to 206 at September 30, 2022, and a reduction in the company's director fees of approximately $0.2 million relating to a modification of the compensation agreement for the Board of Directors. Other income net for the fiscal years ended September 30, 2022 and 2021 was approximately $37.8 million and approximately $31.9 million, respectively. The increases in other income net was primarily due to the recording of higher gains on sales of real estate, property equipment and assets held for sale in fiscal year 2022 as compared to the previous fiscal year. For the fiscal year ended September 30, 2022, we recorded gains on sale of real estate property and equipment and assets held for sale of approximately $41.1 million relating to the sale of approximately 9,400 acres from the Alico Ranch to several third parties. By comparison, for the fiscal year ended September 30, 2021, we recognized gains on sale of real estate, property and equipment and assets held for sale of approximately $35.9 million. Additionally, a decrease in interest expense of approximately $0.7 million for the fiscal year ended September 30, 2022 as compared to the fiscal year ended September 30, 2021, was realized due to the reduction of our long-term debt and making of mandatory principal payments along with other prepayments. During the fiscal year ended September 30, 2022, we received approximately $1.1 million of additional proceeds under the Florida Citrus Recovery Block Grant program relating to Hurricane Irma damage sustained in September 2017. Through September 30, 2022, we received approximately $25.6 million of proceeds under this program. These federal relief proceeds are included as a reduction to operating expenses in the consolidated statements of operations. During the first quarter of fiscal year 2023, we have received the remaining portion of the funds that are due under this program related to the reimbursement of certain crop insurance expenses incurred by us of approximately $1.3 million. For the fiscal years ended September 30, 2022 and September 30, 2021, we reported net income attributable to Alico common stockholders of approximately $12.5 million and approximately $34.9 million, respectively. Our adjusted EBITDA was approximately $13.4 million for the fiscal year ended September 30, 2022 as compared to approximately $25.3 million for the fiscal year ended September 30, 2021. We continue to strengthen our balance sheet. Our working capital was approximately $15.1 million at September 30, 2022, representing a 1.91 to 1 ratio. Our debt-to-equity ratio continues to improve. At September 30, 2022, September 30, 2021 and September 30, 2020, the ratios were 0.45 to 1, 0.50 to 1 and 0.67 to 1, respectively. This improvement has been driven by continued mandatory prepayments on the long-term debt as well as certain voluntary prepayments including approximately $15.6 million in April 2022 on our variable rate term loans. Due to the uncertainty related to the estimated fruit drop and box production, we are unable to provide guidance at this time for fiscal year 2023. During the completion of our annual report on Form 10-K, for the fiscal year ending September 30, 2022, the company identified an error in the calculation of the deferred tax liabilities for the fiscal years 2015 through 2019, resulting in a restatement of balance sheet items as of September 30, 2021, and as of the end of each fiscal quarter previously reported since December 31, 2020. The error had no impact on our consolidated statement of operations or our consolidated statement of cash flows presented in the Form 10-K filed earlier this afternoon, but resulted in a cumulative reduction in deferred tax liability and a corresponding cumulative increase in retained earnings of approximately $2,512,000 on our audited consolidated balance sheet as of September 30, 2021. Thanks, Perry. As we have discussed, although it was a challenging year for our company and the Florida citrus industry, we were able to strengthen our balance sheet for reductions in our debt levels and returned approximately $15.1 million in dividends back to our shareholders. Alico has paid common dividends to shareholders consistently since it became publicly held more than six decades ago. Rate of increased dividend payments since 2019 has been a source of pride as ranch sales proceeds and operations enabled significant amounts of capital to be returned to shareholders. However, taking into account the impact of the recent storm, Alico's Board of Directors unanimously voted to reduce its next quarterly common dividend to $0.05 per share. We believe the investments that Alico has made over the past several years have created what we believe to be the most productive citrus groves in Florida. We will continue to blend a conventional agriculture investment with the ability to optimize the returns on our real assets. We are continuing to work with land-use planning professionals to develop and implement this strategy over the next several years, which we expect to help generate greater returns for our shareholders through active land management. Thank you. Ladies and gentlemen, at this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Gerry Sweeney with ROTH Capital. Please proceed with your question. Curious if you could give us a little bit of insight maybe on the crop insurance status sort of process that you have to go through in timing when you fully understand what the availability of insurance, if any, is on – and then, yes, sorry... No, we'll take them in order. We have crop insurance on all of our acres. It's primarily catastrophic. So it's going to measure a very, very significant crop damage. And we don't think that is going to be affecting a majority of our groves. It certainly is going to affect quite a few of them, but not all of them. And we really can't measure at this point until the end of the crop season until the actual harvest itself. We do estimates right now, but we're actually going to have to measure the actual results. So it's going to be a few more months. Got it. I got to switch gears a little bit and kind of step back to. But when do you sort of get – when do you get some visibility on the quality of the harvest? And Again, just to be clear, the harvest, the fruit that came off the tree during Ian was for this season coming up. So we won't really even know for probably a good solid year as to what like a big rebound or what kind of rebound we're going to have. Is that correct? Yes, similar to what we saw in Hurricane Irma back in 2017. So we'll take those in order. So yes, we actually started harvesting our early and mid-season varieties about a week or so ago. And that crop was probably the most affected. And again, you have to take this with a grain of salt because we still have a lot of evaluation to do because it was just more mature and larger hanging on the tree when the hurricane and all those force winds came through in September. It's too early for us to really tell what that size crop. So unfortunately, we can't give guidance right now or eventually what the ultimate quality standard and kind of juice quantity is going to be. The Valencia season, most likely is going to start in kind of mid-February, we're anticipating certainly affected by the storm, but not as affected by the storm. So there's some reason for some small semblance of optimism there. It's just a timing issue for us with these disclosures because we don't really know all that much today, certainly no more than we did in September. But in another few weeks, we should have much better ideas relative to kind of the early mid crop and its quality standards. Got it. With visibility as it relates to, we'll say, fiscal 2024 early in mid, when would you sort of get a visibility on that harvest, right? So next year harvest. Would that sort of be August, September of this year coming up? Yes. So traditionally, we do kind of our first crop forecast internally in kind of the late summer months. So it would be kind of August going into early September that is traditional. And that will give us our first visibility into the first glimpse of what the crop or next season looks like. And again, it would be a waiting game to make sure that the fruit stays on the tree and matures. As we saw in Irma, there was a very quick rebound. We don't want to go out on a limb and actually say that we expect that, that's going to happen. We will keep our fingers crossed, obviously. But prior to Irma, it would have taken two-plus years to kind of rebound to preproduction levels. So it's unfortunately just going to be another waiting game to get to next summer for the first glimpse and then fingers crossed as we start the next harvest season next November, December. Got it. Going back to the insurance part. Federal relief, any updates on that? I know that's going to be a process, but if anything has moved in the last week or two, a couple of weeks? Yes. Unfortunately, and this is starting to sound like a theme, but unfortunately, we don't have a lot of good visibility that's come out of Washington. Most likely is not going to be a state-driven program. It's almost entirely going to be dependent on kind of federal funding. And we are in kind of wait mode. We're working very closely with Citrus Mutual, our industry trade group. That's kind of the point on this initiative on behalf of all the citrus growers in the state of Florida. Got you. And on federal relief and again, I apologize for the questions here. But since I assume some of this – there was thought of declared a state of an emergency or I think probably at the state and federal level. Does that automatically – I don't want to say automatically, but does that open the door for federal funding? Or is that a whole – this federal sort of relief funding a whole separate process? Yes. We think it's a whole separate process similar to what it was in the past. This isn't like a theme disaster emergency. It's really going to be specific earmark funds for kind of industry-type relief I think back in very early October, Senator Rubio and sponsored some sort of legislation and outlined a program that was very, very large and hopefully, that initiative or something similar to that will continue because those funds really, really can go a long way, both for Alico and our friends and peers to keep the citrus industry alive and growing for generations to come here in Florida. Okay. One more on the real estate side. Just curious if – how the market looks backlog, sort of tone tenor in terms of how properties, demand or activity on the property sales front? Sure. We saw them get into a really big statistics or information that we have [indiscernible] in the press release. We have closed a few small transactions in this quarter. As we said in the press release, it is at prices that we consider to be attractive. So there is continued demand. We've got several other buyers that are negotiating or in a contract stage at this point. So we are still active on the real estate front relative to the Alico Ranch. Thank you, everyone, for joining our call today and also for your support of Alico. On behalf of Perry and myself and the rest of the Alico team based down here in Fort Myers, Florida, we look forward to speaking with you about our first quarter results coming up in February. Thanks very much. Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.
EarningCall_1438
Good day, ladies and gentlemen, and welcome to The Toro Company’s Fourth Quarter and Full-Year Fiscal 2022 Earnings Conference Call. My name is Josh, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today’s conference. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today’s conference, Julie Kerekes, Treasurer and Senior Managing Director of Global Tax and Investor Relations. Please proceed Ms. Kerekes. Thank you, and good morning, everyone. Our earnings release was issued this morning and a copy can be found in the Investor Information section of our corporate website, thetorocompany.com. As a reminder, we have introduced a quarterly earnings presentation as well as an updated general investor presentation, both of which are available on our website. On our call today are Rick Olson, Chairman and Chief Executive Officer; Renee Peterson, Vice President and Chief Financial Officer; Angie Drake, Vice President of Finance; and Jeremy Steffan, Director, Investor Relations. We begin with our customary forward-looking statement policy. During this call, we will make forward-looking statements regarding our plans and projections for the future. This includes estimates and assumptions regarding financial and operating results as well as economic, technological, weather, market acceptance, acquisition-related and other factors that may impact our business and customers. You are all aware of the inherent difficulties, risks and uncertainties in making predictive statements. Our earnings release as well as our SEC filings details some of the important risk factors that may cause our actual results to differ materially from those in our predictions. Please note that we do not have a duty to update our forward-looking statements. In addition, during this call, we will reference certain non-GAAP financial measures. Reconciliations of historical non-GAAP financial measures to reported GAAP financial measures can be found in our earnings release and on our website in our investor presentation as well as in our applicable SEC filings. We believe these measures maybe useful in performing meaningful comparisons of past and present operating results and cash flows to understand the performance of our ongoing operations and how management views the business. Non-GAAP financial measures should not be considered superior to or a substitute for the GAAP financial measures presented in our earnings release and this call. Thanks, Julie, and good morning, everyone. We were pleased to close our fiscal 2022 with record top and bottom line results for both the fourth quarter and the full-year. Throughout the year, we benefited from our pricing actions supported by strong demand for our innovative products, especially in our key professional markets. Importantly, we began to see improvements in our supply chain and in our manufacturing efficiency in what remains a very dynamic operating environment. Our entire organization executed extremely well. We drove operational improvements with lasting benefits and collaborated with our channel partners to support the needs of our customers. For the fourth quarter, net sales were up 22% over last year, and adjusted diluted earnings per share were up 98%. Our revenue and profit growth were driven by pricing, volume gains and improved productivity. For the full-year, our top line exceeded $4 billion for the first time, with net sales of $4.5 billion, up 14% year-over-year. Our adjusted diluted earnings per share were $4.20, up 16%. I'll now highlight our full-year results by segment. For fiscal 2022 on a year-over-year basis, Professional segment net sales were up 17%. We capitalized on continued broad-based demand and drove pricing actions to mitigate inflationary pressures. We closed the year with substantial backlog levels, most notably in our underground and specialty construction and golf and grounds businesses. With this heightened order book, our top line results were driven by our ability to produce in what remained a constrained supply environment. Residential segment net sales were up close to 6%. This was on top of two prior years of incredible net sales growth, up 23% in fiscal 2021 and up 24% in fiscal 2020. Our actions to introduce innovative new products, refresh brand marketing and expand distribution have fundamentally reset this business and have positioned it well for the future. Across our organization, we delivered strong performance this year. We executed on key strategic initiatives to capitalize on very positive secular trends in markets where we have leadership positions. First, we strengthened our innovation leadership with technology forward product introduction. This includes the expansion of our no-compromise battery electric and smart-connected offerings across our portfolio. We also introduced autonomous products with industry-first features in our golf and residential businesses. We are excited to develop next-generation solutions to help customers achieve their emission reduction goals while addressing their labor challenges and increasing productivity and precision. Second, we prudently deployed capital for sustained long-term growth. This included prioritized investments in research and development and key capital projects as well as our Intimidator Group acquisition. This acquisition expanded our geographic reach and leadership position in the large and rapidly growing zero-turn mower market. It builds on our history of successful acquisitions enabled by our effective capital allocation and strong balance sheet. Third, we focus on driving the best outcome for all stakeholders. Our team and channel partners served our customers, supported each other in our communities and did business the right way. We delivered record net sales and earnings while investing in future growth, returning capital to shareholders and maintaining financial flexibility. We also continue to live our long-standing commitment to ESG as we establish performance goals in our most recent sustainability report. We are starting the new fiscal year with great momentum and we will continue to execute against our enterprise strategic priorities of accelerating profitable growth, driving productivity and operational excellence and empowering people. I'll discuss our outlook further following Renee and Angie's more detailed review of our financial results and guidance. Well, thank you, Rick, and good morning, everyone. As Rick said, we delivered record results for the quarter and full-year. These results were driven by continued strong demand, especially across key professional markets as well as pricing benefits and disciplined execution in what remains a very dynamic operating environment. We grew fourth quarter net sales by 22% year-over-year to a record $1.17 billion. Reported EPS was $1.12 per diluted share and adjusted EPS was $1.11 per diluted share, both up from $0.56 in the prior year. For the full-year, net sales increased 14% year-over-year to a record $4.51 billion. Reported EPS was $4.20 per diluted share, up from $3.78 last year. Full-year adjusted EPS was also $4.20 per diluted share, up 16% from $3.62 last year. Now to the segment results. Professional segment net sales for the quarter were $944.7 million, up 29% year-over-year. This increase was primarily driven by net price realization, incremental revenue from our acquisition of the Intimidator Group, and higher shipments of zero-turn mowers, golf and grounds equipment and snow and ice management solutions. For the full-year, Professional segment net sales increased 17.1% to $3.43 billion and comprised 76% of the total company net sales. Professional segment earnings for the fourth quarter were up 58% to $159 million, and when expressed as a percentage of net sales, 16.8%, up from 13.8% last year. This increase was primarily due to net price realization, net sales leverage and productivity improvements, partially offset by higher material, freight and manufacturing costs, and the addition of Intimidator Group at a lower initial margin relative to the segment average. For the full-year, Professional segment earnings were $584 million, an increase of 15.1% compared to fiscal 2021. As a percentage of net sales, segment earnings were 17%, down slightly from 17.3% last year as a result of the Intimidator acquisition in the first quarter. Residential segment net sales for the fourth quarter were $223.5 million, down about 1% year-over-year. This was primarily due to lower sales of walk power and zero-turn riding mowers and portable power products, largely offset by net price realization and higher shipments of snow products. For the full-year, Residential segment net sales increased 5.8% to $1.1 billion and comprised 24% of the total company net sales. Residential segment earnings for the quarter were $17.5 million, and when expressed as a percentage of net sales, 7.8%, up from 5.3% last year. The year-over-year increase was primarily driven by net price realization, productivity improvements and favorable product mix, partially offset by higher material, freight and manufacturing costs. For the full-year, Residential segment earnings were $112.7 million, a decrease of 7.2% year-over-year. On a percentage of net sales basis, segment earnings were 10.5%, down from 12% in fiscal 2021. Turning to our operating results. Our reported and adjusted gross margins were 34% and 34.1%, respectively, for the fourth quarter. This was up from 30.1% for both in the same period last year. The increases were largely due to net price realization, productivity improvements and product mix. This was partially offset by higher material, freight and manufacturing costs and the addition of Intimidator Group at a lower initial gross margin relative to the company average. For the full-year, reported and adjusted gross margins were 33.3% and 33.4%, respectively. This was down slightly from 33.8% for both in fiscal 2021. SG&A expense as a percentage of net sales for the quarter was 21.2%, compared to 22.4% in the same period last year. This positive performance was primarily driven by net sales leverage and lower incentive costs. For the full-year, SG&A expense as a percentage of net sales was 20.5%, a slight improvement compared to 20.7% last year. Operating earnings as a percentage of net sales for the fourth quarter were 12.8%, compared to 7.7% in the same period last year. For the full-year, operating earnings as a percentage of net sales were 12.8%, down from 13.1% in fiscal 2021. Adjusted operating earnings as a percentage of net sales for the full-year were 12.8%, the same as the year ago. Interest expense for the quarter was $11.5 million, up $4.5 million year-over-year. Interest expense for the full-year was $35.7 million, up $7 million. These increases were driven by incremental borrowings to fund the Intimidator Group acquisition and higher average interest rates. The reported and adjusted effective tax rates for the fourth quarter were 17.9% and 18.5%, respectively, and for the full-year, 19.8% and 20.2%, respectively. Turning to our balance sheet and cash flows. Accounts receivable were $332.7 million, up 7% from a year-ago, primarily driven by organic net sales growth and our acquisition of Intimidator Group. Inventory was $1.05 billion, up 42% compared to last year. This increase was driven by higher finished goods, work in process and service parts. In addition, this includes the impact of inflation and incremental inventory from our Intimidator Group acquisition. We expect our inventory composition and turnover to improve during fiscal 2023 as we manage through this unique environment. Accounts payable increased 15% from last year to $579 million. This was primarily due to higher purchase activity and inflation, improved payment terms, and the Intimidator Group acquisition. Free cash flow was $154 million, with a conversion ratio of 35% of reported net earnings. This conversion came in under our expectations, largely due to the current supply chain environment, which showed higher investments in work in process and service parts as we focus on putting ourselves in the best position to produce equipment and serve our customers. During fiscal 2023, we intend to improve our work in process levels and return to a more normalized inventory composition. Importantly, our balance sheet remains strong, and our gross debt-to-EBITDA leverage ratio is well within our target range of 1x to 2x. We continue to allocate capital with our disciplined approach and the same priorities, which include making strategic investments in our business to support long-term profitable growth, both organically and through acquisitions, returning cash to shareholders through dividends and share repurchases and maintaining our leverage goals to support financial flexibility. These priorities are highlighted by our actions this year including our deployment of $143 million in capital expenditures to fund new product investments, advanced manufacturing technologies and capacity for growth. Our $400 million acquisition of the Intimidator Group, the return of $266 million to shareholders through regular dividend payments of $126 million and share repurchases of $140 million and the paydown of $100 million in debt. These actions, along with our focus on operational execution continue to position us well for the long-term. We are pleased to share that our Board recently approved a 13% increase in a regular quarterly dividend for the first quarter of fiscal 2023 and added 5 million shares to our repurchase authorization. Thank you, Renee, and hello, everyone. Looking ahead to 2023, I'd like to start with some commentary on our $2.3 billion order backlog. Our backlog has remained elevated the past two years, driven by the strong demand we've experienced coupled with a challenging supply chain environment. In fiscal 2022, we started to see some improvements in our supply chain and continue to adjust our production and operations for efficiencies. Most of our current backlog consists of orders for underground and specialty construction and golf and grounds equipment. This is where we've had the highest level of supply chain disruption. We continue to take measures to ensure pricing is current at the time of order fulfillment, and this provides a strong base for 2023. With that background in mind, along with our current visibility in this dynamic and evolving environment, we are providing the following guidance for fiscal 2023. For the full-year, we expect net sales growth in the range of 7% to 10%, and we anticipate the return to a more typical quarterly sales cadence with Q2 and Q3 being our larger quarters. For the Professional segment, we expect a net sales growth rate higher than the company average. For the Residential segment, we expect net sales to be relatively flat. Looking at profitability. For the full-year, we expect improvement in overall adjusted operating earnings as a percentage of net sales compared to last year, driven by higher earnings margins in both segments. We expect net price realization and productivity improvements to drive year-over-year improvement in gross margin and a higher gross margin in the second half of the fiscal year compared to the first half. With this backdrop, we anticipate full-year adjusted EPS in the range of $4.70 to $4.90 per diluted share. This adjusted EPS estimate excludes the benefit of the excess tax deduction for stock compensation. Turning to the first quarter. We anticipate a total company Q1 net sales growth rate that is meaningfully higher than our full-year expectations. We expect this to be driven by our Professional segment, which will include the impact of incremental revenue from our 2022 acquisition of the Intimidator Group. We expect Residential segment net sales to be relatively flat. Looking at profitability, for the first quarter, we expect modest improvement in gross margin and a similar SG&A rate, both compared to last year. We also expect higher interest expense in the quarter year-over-year, given the incremental debt to fund the Intimidator Group acquisition and higher interest rates. Looking at segment profitability for the first quarter, we expect the professional margin to reflect an incremental expense of about $5 million as a result of our inventory valuation methodology and the timing of inflation. With this, we expect the professional margin to be down sequentially compared to the fourth quarter of fiscal 2022, but still higher year-over-year. We expect the first quarter residential earnings margin to be similar year-over-year. Overall, we expect our first quarter fiscal 2023 adjusted EPS per diluted share to be higher than last year, but down sequentially from the fourth quarter of fiscal 2022. As Renee mentioned earlier, we are focused on improving our inventory position. As a result, we expect to return to a normalized free cash flow conversion of approximately 100% of adjusted net earnings in fiscal 2023. Additionally, for the full-year, we expect capital expenditures in the range of $150 million to $175 million, depreciation and amortization of about $130 million, interest expense of about $55 million and an adjusted effective tax rate of about 21%. Fiscal 2022 was a record-setting year for The Toro Company and reinforced the agility and resiliency of our teams. We are focused on operational excellence, and we will continue to build on incremental supply chain improvements. We remain confident in our long-term strategies and look forward to building on our positive momentum in fiscal 2023. Thanks, Angie. As we head into fiscal 2023, we are well positioned with innovative products, trusted brands and extensive distribution and service networks. We expect to benefit from our well-established market leadership, along with the essential nature and regular replacement of our products. On top of that, we are entering the year with an order backlog of over $2 billion, the majority of which is for products in the areas of underground and specialty construction and golf and grounds. From a broader perspective, we are keeping an eye on overall business confidence as well as consumer sentiment and spending patterns. We are also monitoring inflation, monetary policy actions and the geopolitical environment. We believe we are well prepared to navigate this heightened level of macro uncertainty. I'll now comment on the macro factors we are seeing in our end markets, which could impact future results, starting with our Professional segment. For underground and specialty construction, we expect the current robust demand to continue with public and private infrastructure investments, providing a multi-year tailwind. Utility, construction and rental markets currently show no signs of slowing down driven by the need and support for broadband and alternative power build-outs, along with the aging infrastructure. For example, the American Society of Civil Engineers estimates that a water main breaks every two minutes. And there are 6 billion gallons of treated water lost each day in the U.S. alone. With the most comprehensive equipment lineup in the industry, including solutions for new installations, repair, rehab and replacement, we are actively addressing the serious environmental and economic issue. For golf, we expect strong demand to continue as course budgets are healthier than ever. In the U.S., rounds played in 2022 are on track to once again end the year well above pre-pandemic levels. And the overall participant base is expected to exceed $40 million for the first time in history. As the only company to offer both equipment and irrigation solutions and is the market leader in both, we are extremely well positioned to build on our momentum and long-standing relationships. For example, we were recently named the official equipment and irrigation partner for Asian tour destinations, an exclusive network of world-class golfing venues. We were selected because of our high-quality products, exemplary service and support and legacy of trusted relationships. For municipalities and grounds, we expect to continue to see healthy budgets and the prioritization of green spaces, along with increasing interest in zero-exhaust emission products. For customers seeking sustainable solutions, we are well positioned with our growing suite of no compromise offerings geared to professionals. For snow and ice management, the season is off to a good start with record preseason bookings and storm activity driving healthy contractor revenue. In addition, we have a steady cadence of new product launches to enhance our leadership in this space. This includes the versatile new snow raider Mag. This system allows one operator to do the work of eight shovelers on a job site and our new liquid deicing solutions significantly reduced the amount of salt required. For landscape contractors, we expect to see a more normalized seasonal cadence with some degree of influence from weather patterns. This large growing market remains extremely attractive. Our extensive channel plus three brands, Exmark, Toro and Spartan position us well to increase our leadership in this space. Customers are seeking solutions that drive productivity and efficiency and there is growing interest in options that reduce exhaust emissions. This includes our Exmark and Toro commercial-grade battery powered stand-on and zero-turn mowers. These mowers last the entire workday on a single charge with no sacrifice in performance. We also expect demand for certain of our battery and hybrid electric offerings to get a boost from tax credits included in the U.S. Inflation Reduction Act. If applicable, these credits could drive a faster payback period for qualifying customers when considering the total cost of ownership. For residential, commercial, irrigation and lighting, we are watching for any shifts in consumer spending patterns as well as housing market trends. Sustainability is ingrained in our approach to this business. We were honored to receive our eighth consecutive EPA WaterSense Award in October for our outreach and education around efficient water use. For agricultural micro irrigation, we expect a normalized year for purchasing patterns and are monitoring drought conditions in key regions. Our customers remain focused on solutions that drive efficiency and precision to grow more food with less water. Moving to the Residential segment. We continue to see demand return to more typical seasonal trends. With this normalization, we will be watching weather patterns, including snow activity, the timing of spring and the extent of any drought conditions. More broadly, we will be watching consumer confidence. Importantly for us, we benefit from regular replacement cycle. In addition, the current demand normalization is on top of the higher base we have built over the past few years with our expanded channel partners. We've also grown our addressable market with the ever-increasing number of tools and attachments in our Flex-Force 60-volt battery lineup, and we will be entering the autonomous space for homeowners with our robotic mower that was announced earlier this year. We've entered the new year with an outstanding team of employees and channel partners and strong momentum. We believe we are well positioned to build on our market leadership across our broad portfolio as we continue to prioritize technology investments in alternative power, smart connected and autonomous solutions. Importantly, we plan to leverage these investments across our businesses to drive value for all stakeholders. We believe we have a unique competitive advantage, driven by our innovation and market leadership, prudent capital allocation, enterprise-wide operational excellence and valued network of deep relationships. On that note, I would like to thank our employees and channel partners for going above and beyond every day to support our customers and deliver great results. You are the key to The Toro Company's success. I would also like to extend my gratitude to our customers and shareholders for your continued support, and I wish everyone a fantastic holiday season. Good morning. I guess for you, Renee, on you guys called out through the prepared remarks your price realization in 2022. And I know you don't provide a lot of detail, but I'll maybe throw it out there anyway – anyway you can kind of shape it up and then your expectations for 2023, how much price realization is in your expectations are – the more or less about the same anything you can provide on that color would be great? Yes. We expect to see our demand continue to be solid for our products. We're going to continue with pricing to the market as we have typically done. And we do expect to see 7% to 10% sales growth in the year for our full-year guidance. We will probably see more price than volume, but it will be a mix really of both price and volume. And I think we just continue, Tom, to feel like we're going to be agile and focus on productivity and adjust where we need to. Okay. Thanks. And then just maybe as a follow-up, Rick, you talked about supply chain getting a little bit better. I think last time we spoke, you said maybe upwards of 50% of the items that at the worst of the supply chain issue maybe getting a little bit better. It sounds like it continues to get better. I just – how do you see that progressing through this year? You're right. We are seeing improvement, steady improvement in the supply chain. I think especially if you benchmark last year at this time, as I look back at my notes, if we had an assembly line that was not running and I called one of our plants, and asked why that was, they would say, we don't know where to start. We've got so many supply issues and suppliers that can't give us dates. Today, that's a much different picture. We're down to a more discrete group of suppliers that are still challenged in a more discrete group of components that are challenging. Those are the categories you probably hear from others, everything electronic. So chips, wiring harnesses, some hydraulic components and a few engines, but it's a much more definable group than it was a year-ago at this time and it continues to show steady improvement. Happy holidays to you as well. I got like two or three questions. I'll try and make them real quick. So I think I heard you say that you're looking to work your inventories lower as the year progresses. Can you add a little bit of color or quantification of that in terms of what's a realistic goal from a dollar perspective that you can get inventories by fiscal year-end versus the $1 billion here? And then same question, how much of that $2.3 billion in backlog are you looking – or are you including within your 7% to 10% sales growth guidance that would be worked lower? Rick, maybe I'll take the first question – if you want to talk about the backlog. I guess looking at free cash flow generation, inventory was the driver for our conversion rate within fiscal 2022, which was lower than our historical average. Important to note that we did come off of two very strong years, free cash flow conversion at 140% in fiscal 2020 and 110% in 2021. As we look forward, same we don't have a specific guidance number related to inventory because we'll manage all of the variables that impact our cash flow, but we do feel that we will return to a more normal level of free cash flow conversion. And as Angie talked about, we expect that to be about 100% for the year. So that's embedded in that guidance. As you look at the backlog going forward, Sam, the bulk of backlog, the largest portions that are coming from underground, specialty construction, golf and grounds has been consistent in our conversations previously. And we will be working to bring down the backlog. In some cases, that can be done more quickly because the supply chain constraints has resolved more quickly. Others will extend out throughout the year, but we know we're going to be managing the backlog throughout the year. From a capacity standpoint, we will – we're adding capacity in areas that have long-term growth and capacity needs beyond the short-term and the areas that are more of a short-term issue, we're looking to double down on our existing operations, whether we're using other facilities to make some of the products or the opportunity to add shifts and so forth. That's really subject to the availability of components still at this point. So as the supply chain gets healthier, we'll look for options to continue to bring the backlog down as quickly as possible. And we're working with our channel partners and our customers to make sure we support our customers, which is our top priority in this environment. And just adding to that, going back to the inventory question, they're really related to, as we've looked at trying to serve our customers to the best of our ability, given the demand that Rick was just talking about, we have made some strategic decisions to bring in some key components. And we think that served us well, but we'll continue to manage that inventory as the supply chain normalizes. So could I infer then or could one infer that based on the improvements you've been seeing in supply chain and the fact that the season is going to be starting in the next few months or so, that backlog would be worked lower perhaps as soon as – as this existing quarter? Or is it going to be more of a springtime thing when we should see sequential backlog declines? I think we're looking at it over the course of the year. So our best estimate is built into our guidance. And certainly, the spring is a opportunity with natural flow for demand for that to come down. But again, the bigger spring push is really on our Residential side and most of the backlog in this case is really on the Professional side. Sorry, Sam, I was just going to add to that to say we'll really kind of return to a more normal cadence of sales per quarter and seeing our larger quarters be in Q2 and Q3 of F2023. And so my final thought as it relates to resi, there's clearly a lot of moving pieces here in the channel with respect to channel inventories and weather normalization and maybe some push ahead demand from prior periods. How do you categorize the sell-through expectations both from a volume and pricing standpoint this coming year that informs your expectations for flat resi sales growth? Thanks. Yes. I think, Sam, we described it as a more normalized situation. So we've got better field inventory positions than we've had the last couple of years in residential. We're still short in a few key product categories that we're looking to sell in, in the field. And then it will be subject to the normal, the timing of spring, the weather patterns and so forth. And 2022 is not a great year for residential from a external perspective with a very late spring and a drought in the summer. So we've already kind of seen somewhat of a return to more normal patterns in 2022, and we did grow the business by 6% in that circumstance. And residential has been an absolute superstar through 2021 and 2020 growing more than 20%. So we're really talking about normalizing on a new plateau of that business based on additional channel partners, the reboot of the product line, marketing and merchandise positioning, et cetera. So it's a different business than it was a few years ago. Hey, everybody. Good morning, happy holidays. Maybe just on the guidance around margins. I mean, it sounds like you'll actually have less expansion in the first half of the year than the second half of the year, even though I think that the comps in the first half were easier than the second half. So could you just maybe walk us through what specifically is kind of driving that? Just I would have thought it would have been a little bit better in the first half just given the timing of price cost? Yes. I think what you'll see there is that we do expect Pro to be higher year-over-year, but down sequentially from Q4. Part of that is the inventory adjustment that we had to make in Q1, which is just kind of part of a normal process that we do. But this quarter, it was a bit higher – significantly higher than we had to do in prior years, really related to the increased inventory and the inflationary environment. But we did that just to call that out really to help you guys in your modeling, but that will affect our Pro margin a bit, and res will be similar year-over-year. We do expect that this will kind of normalize as we go into Q2 and Q3. Although interest expense is also a piece of that, and it will be higher year-over-year. And then finally, when we look at our adjusted EPS, it's higher year-over-year, too. And our range is going to be 12% to 17% higher year-over-year for the total year, yes. For the total year. Okay, yes. I mean, I guess maybe asked a different way, like I guess your implied incrementals are kind of mid-20% for 2023. And I don't think that's much different than your kind of normal incrementals. And I would think you'd have more productivity and kind of better price cost as being kind of tailwind. So I guess just kind of – I guess what are you baking in for kind of the net price cost kind of tailwind on the margin side for 2023? Yes. We're continuing to see positive price realization. We're still in an inflationary environment, though, Tim, what we're seeing. We are seeing some favorable trends from a commodity standpoint. But all of that, we're certainly not seeing in our P&L as of today. It's also important to consider in Q1 when you're looking at just Q1, we did have the Intimidator Group acquisition, which is an impact in Q1 that we wouldn't have had last year. And we talked about that as just at a lower initial gross margin than the segment average. That would be the only other thing I would mention. Okay. Good. And then I guess from a landscape contractor perspective, it sounds like you're expecting kind of more normalized demand patterns in fiscal 2023 in that business? I mean does that imply that the channel from kind of an inventory and a kind of floor planning perspective is kind of return to normal? I think in general, it is a little bit more returning to normal as expanding on what I said before. We do have key product categories and especially on the more higher end of LCE, the more professional higher horsepower products. We still are short products in the field for those categories. So certainly much more demand even to put the field inventory in the right place for those, but good flow-through still from professional contractors I would just say for some portion of that business also goes to homeowners with acreage, so that's another factor that's a little bit more closely aligned with residential. Okay. And then just last one. On the golf and the underground businesses, are you effectively sold out for this year or I guess, fiscal 2023? And I guess I'm looking at the backlog and trying to think about how big those businesses are from a revenue perspective. And I think the backlog is probably bigger than what those two businesses generate on an annualized basis. So I guess I'm just curious if you're already booking those businesses out to kind of fiscal 2024 and what the lead times look like and kind of golf and underground today? It's not true universally across those categories, but it's true in some key categories, yes, that were booked out through the year. Thanks to the earlier comments, we're working on how we can overdrive our production in some of those areas, those components become available without adding regrettable capacity that we'll have to deal with in the future. Okay. And when you think about CapEx, I mean, is it really devoted to those two businesses on a go-forward basis? Not universally, it's overweighted to those areas as especially the underground specialty construction side that has long opportunities going forward here relative to the secular trends and the drivers of infrastructure spending and investment. So that would have more capital investment, long-term perspective. On backlog, a couple of points of clarification. But the $2.3 billion number, that number a year-ago was $1.5 billion. Is that correct? And that – and normalized, if we go back to 2019, that number in the more normal period is roughly what? If you look at the average over a number of years prior to or including 2019 and before, it's more in the 150% range, it's roughly was 10x last year at this time. Okay. And so the growth in 2022, I guess what I'm trying to figure out is the number grew $700 million or 40% this year. And your supply chain improved back-end loaded, it sounds like within the year. But the further growth of that number. Is this – can you just give us a sense – I mean, obviously, backlog is the sum or the difference between demand and supply. But can you just help us understand what contributed to that growth this year in those metrics? Yes. It's really the narrative on the backlog for 2022 is that our supply chain got better. We were able to fulfill lot of the backlog that was there when we started. And the demand was even more than what we could fulfill. So basically, the answer is incredibly strong demand in those areas underground specialty construction and the golf and grounds market. So we've got better the supply chain got better, we were able to ship more and the demand came in at a faster rate. Okay. And then related to that, secondly, the revenue guide for 2023 of up $7 million to $10 million. I guess as I look at the backlog number relative to last year relative to historic context, with incremental supply is – the limiting factor of this is supply, it's not demand by it feels like multiples? Or am I thinking about backlog wrong? Generally, that is true. Yes, it's a supply-driven constraint rather we have – as you can see, we have a lot of demand. And that's been really our theme for the last – throughout the last year plus. Okay. And then the last question I have relates to inventory. Your directional comment that you would make progress on inventory in 2023 is – in terms of operating rates or utilization rates, there's a lot of other companies in your neighborhood that have too much inventory, and they'll solve it by producing less. Is your inventory more a function of shipping more? Or are there – do you have to – I don't believe my question, do you have to idle capacity? Or is this just – there's enough supply we can complete product and then get it out the door. Like is the improvement in inventory have any impact on operating rates or incremental margins? Or is it the alternative? Yes. No, I don't think we'll be producing less. It's really more weighted, Eric, towards work-in process and service parts because, again, we intentionally brought in some of those components to try to get more efficiency out of our production facility. So I think we'll be producing at a high rate. We actually are a little light on finished goods in a number of areas. As Rick was talking about, where we have very strong demand, we're not holding a lot of finished goods. We're shipping that out as soon as we can make it. So when we talk about normalizing the mix, it's really normalizing, bringing down work-in process and finished goods up as a percentage, total inventory down. And I would just add to that, we are – today, we are a larger company. And so we've also got inflationary rates a bit in our inventory, but we do believe the inventory is good. We're not seeing a lot of excess and obsolete, it's good inventory. Yes. Good morning. Thanks for taking the questions. I guess, first of all, thanks for the additional guidance around the first quarter by – if I were to think that you were going to provide that quarterly guidance on a consistent basis going forward, that would be a huge help. So thanks for that. But it's likely to be a base case, right? So I guess I'm just trying to understand, if we end up with a slowdown in demand in 2023 and it doesn't play out in accordance with the base case, but rather comes in lighter than that. Rick, where in the P&L are your greatest opportunities to flex or to protect margins? I think this is something that The Toro Company has done just by nature of our markets and our businesses. We know that some of our businesses are affected by weather cycles and so forth. So we stay very agile in the way that we do our planning for the year and our budgeting. So we tend to budget in a way that significant investments are held until we can see how the year is starting to play out. We'll leave flexibility in some of those investments as we go through the year. We have flex opportunities with our suppliers and so forth as well. So we – that's the way that we build our plan for the year to be able to flex should the conditions change and we stay current with the level of demand. So that's how we do our business. Yes. And I would just say from a professional standpoint, there's a lot of our professional customers have not been able to get the products that they need and they want. So we do have kind of a bit of pent-up demand on the professional side. Certainly, some of it constrained by supply chain, but also just the fact that people have been wanting to get that product. And that's probably the key point is most of our products are used for essential tasks. They're not discretionary. So especially in the context of a business, many of our professional customers are – have delayed purchases through the early part of the pandemic, and they're already behind. And our products are consumed when they're used. So if they're being used then they're being consumed and they need to be replaced. But also say we're just – we're off to a really good start with snow, as you can imagine, both on the professional and the residential side. We've activated the emergency response system with our channel-to-ship product to the areas that are going to be affected by the storms coming up, and then we've been off to a good start so far this year as well. So it's even in our residential business, that's a really nice way to start out the year as well from a product standpoint. And just to follow-up on your answer. When you talk about investments, so you are really referencing new product development investments? Or is it something else? New product investments are usually the last to go, to be honest, it's more – it could be systems, investments, those types of things that don't affect. Product development is an extremely high priority because innovation is so key to who we are. So that – we don't give those up easily, if ever. Right. I guess secondly, just to reference back to an answer you gave earlier with regard to landscape contractor. Some portion of that obviously does sell into residential markets. Are you able to quantify that for us or give us some sense of how likely that segment is to correlate to residential? I don't think we've quantified that in the past, but it's essentially customers that are looking for professional products or they have properties that justify having professional level products. So large acreages, it could be farms, it could be estates, those types of things that may be buying professional products. So I just didn't want to imply that those all go to landscape contractors. There are other customer types in that category and they're affected differently by economic conditions. Okay. And then finally, I guess, just from a profitability standpoint, I'm just curious on your thoughts around Intimidator. And I realize it's a high single-digit percentage of the Pro segment, but relatively small, but it keeps coming up and sort of the discussion of the dynamics around the margins. So is there any way to sort of help us understand just what the progression plan is there in terms of profitability? And how much long do you expect it to be dilutive to the Pro segment? Yes. And we've called it out because of the first year, it has more of an impact on the financial performance versus when it's in the base comparing year-over-year. As far as acquisition itself, it has been a great acquisition. It is performing in line with our expectations and with the models that we had upon the acquisition. We're realizing the synergies that we had anticipated at this point in time and getting leverage, especially related to some of the technology areas over the broader three brands that we now have within the zero-churn mower market. So we feel really good about the acquisition. We are seeing improvement in their profitability. But really, we didn't expect all of that to happen all in one year, especially given the supply chain challenges. Initially, we want to make sure we got off to a strong start with the brand and maintained the momentum that they had and we'll work over time to definitely to improve their profitability. And I would just add to that in Q1. We expect them to add about $60 million in net sales as part of that net sales increase in the Pro segment. Backlog would be similar to other LCE at this point. So some on key product categories, but the field inventory is in better position there than it would be on the other categories of Pro that we talked about. Yes. And I think the $60 million is consistent from a run rate standpoint with what we've been seeing in the prior quarters as well. It has a little more of a seasonal cadence to it. So Angie is quoting the number for Q1. And that they weren't in our Q1 F2022. Yes. And I think pre-acquisition, they were about $200 million. So they are growing. Thank you, Josh, and thank you all for your questions and interest in The Toro Company. We look forward to talking with everyone again in March to discuss our fiscal 2023 first quarter results. Happy holidays.
EarningCall_1439
Good day, and welcome to the Progress Software Corporation Q4 2022 Earnings Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker, Mr. Michael Micciche, Vice President of Investor Relations. Please, go ahead. Okay, great. Thank you, Sherry. Good afternoon, everyone, and thanks for joining us for Progress Software's fourth fiscal quarter 2022 financial results conference call. With us today is Yogesh Gupta, President and Chief Executive Officer; and Anthony Folger, our Chief Financial Officer. Before we get started, I'd like to remind you that during this call, we will discuss our outlook for future financial operating performance, corporate strategies, product plans, cost initiatives, our proposed acquisition of MarkLogic, and other information that might be considered forward-looking. This forward-looking information represents Progress Software's outlook and guidance only as of today and is subject to risks and uncertainties. For a description of the factors that may affect our results, please refer to the section captioned Risk Factors in our most recent Form 10-K and subsequent 10-Qs. Progress Software assumes no obligation to update the forward-looking statements included in this call whether a result of new developments or otherwise. Additionally, on this call, all the financial figures we discuss are non-GAAP measures unless otherwise indicated. You can find a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP numbers in our financial results press release, which was issued after the market close today. This document contains the full details of our financial results for the fiscal fourth quarter of 2022, and I recommend you reference it for specific details. We have also prepared a presentation that contain supplemental data for our fourth quarter 2022 results, providing highlights and additional financial metrics. Both the earnings release and the supplemental presentation are available in the Investor Relations section of our website at investors.progress.com. As Sherry said, today's call will be recorded in its entirety, and it will also be available via replay on the Investor Relations section of our website. We're happy to be back with you to talk about the results of our fourth quarter and full-year fiscal '22 and to look ahead to fiscal year '23. And we're excited that we can provide you with much more detail about our pending acquisition of MarkLogic. Anthony will discuss the financial results from FY '22, provide guidance for FY '23, and he will also walk us through the financial benefits, impact and timing of the MarkLogic deal. It's a lot to cover, so let's jump right in. Fiscal '22 was another outstanding and eventful year for Progress, during which we saw steady demand for virtually every product in every geography, and exceptional execution from all of our teams in the field throughout the year. Our ongoing efforts to invest in our products and in customer success continued to bear fruit and led to exceptionally high net retention rate of over 101%. We saw customers expand their use and re-commit to our products across the Board. In FY '22, many of our large Chef, OpenEdge and DataDirect customers significantly increased their annual spend with us. Our DevTools products continued to see best-in-class retention rates and products such as Sitefinity cloud and MOVEit cloud saw many new wins around the globe. Operationally, we fully integrated Kemp and folded the business into our existing sales, support, engineering, and customer success platforms as planned. Our workhorse products, OpenEdge and DataDirect, continued to perform solidly above plan, along with Sitefinity, DevTools, Chef, Loadmaster and Flowmon as customers continued to rely on our portfolio to run their mission-critical applications and manage their digital transformation efforts. All of this resulted in our finishing the fourth quarter on a very positive note, most notably with ARR coming in at $497 million, up 3.5% year-over-year. As you know, we consistently beat estimates and raised guidance this year with strong revenues, world-class operating margins, and increasing earnings while maintaining a solid balance sheet. We navigated the tough and rapidly changing economic environment following the outbreak of war in Ukraine, a brief but dramatic resurgence of COVID, the onset of rapid inflation, and we overcame significant FX headwinds. We managed our cost structure very effectively in FY '22. We sold our headquarters and were able to shed the associated burdens of owning real estate. Our employees love our flexible work-from-anywhere model and our leased space in Burlington, which we inherited from Ipswitch, is working perfectly as our new headquarters. We also continued to manage our variable expenses well throughout the year even as we reunited more employees and customers in person, and in some cases, for the first time, since March of 2020. And even more importantly, we maintained high employee engagement and retention rates throughout the year well above the industry averages. We consider employee retention to be critical to our success because retaining employees builds institutional knowledge and is much more cost-effective. We have continued to create and nurture a cultural gear towards teamwork with respect for all accountability, trust, and innovation, which is why Progress continues to win awards year-after-year in the U.S. and abroad as one of the best companies to work for. We're very proud of the success we've had in hiring and retaining a great team. And I believe it shows directly on both the top and the bottom lines of our business. So, all in all, we're very pleased with the fourth quarter and full year '22. I couldn't be more proud of our team or more grateful to our customers and partners. We culminated calendar 2022 by finalizing the terms to acquire MarkLogic, allowing us to kick off 2023 by announcing the signing of a definitive agreement for our largest acquisition yet on January 3. When we announced our total growth strategy in 2019, we made a pledge to shareholders that we would be disciplined, patient, and extremely selective in how we deployed our capital. We have kept that promise and our criteria and commitment have not changed even as the market and the environment around us has. We believe the M&A market will continue to evolve and that our ability to compete will increase as we keep adding infrastructure software acquisitions that create meaningful shareholder returns and generate durable cash flows, making progress the acquirer of choice for target company employees, customers, and sellers. As we said on the call announcing the MarkLogic deal two weeks ago, we think that this acquisition hits the target on every metric, from the ability to create synergies that provides strong recurring revenues, margins, cash flows, and earnings, to a great cultural and technology fit. We look forward to serving MarkLogic's impressive customer list of over 300 companies once the deal closes. From a technology perspective, MarkLogic's multi-model data platform and its capabilities for data integration and semantic analysis of structured and unstructured data will allow Progress to deepen our data offerings and enable customers to consume data, grounded in superior analytics, informed search and fact-based intelligence. MarkLogic products will also extend data capabilities for our DataDirect customers, from structured data integration to natively manipulating, storing, and managing non-relational data such as grass data, triples and other unstructured data, as well as gaining insights by performing semantic metadata analysis and applying AI capabilities to all types of data. Now, let's talk a little bit about our FY '23 expectations, including the expected impact of MarkLogic. We expect demand for our products to remain steady in FY '23 and our ARR to continue to grow modestly. Once MarkLogic is fully integrated, Progress will scale to over $700 million in revenue. Speaking of MarkLogic's financial impact, which Anthony will explain in more detail in a minute, we expect MarkLogic to add approximately $75 million in annual recurring revenue with high retention rates, over $100 million to the top line on a full-year basis, and expect operating margins to improve as we integrate its sales, go-to-market, engineering, and support functions into the Progress platform. It is important to note a few things regarding the timing of the deal and the seasonality of the MarkLogic business. We currently anticipate closing the acquisition in early February and expect MarkLogic to be accretive starting with the first full quarter of our ownership. More importantly, MarkLogic has a January fiscal year-end and about one-third of its revenue is recorded in December and January. Because MarkLogic's two biggest revenue months would have occurred just before the acquisition closes and our fiscal year ends in November, we will only be able to benefit from about two-thirds of their annual revenue in our fiscal year '23 and we'll only see the full-year impact on revenue in FY '24. The deal closing in February also gives us only a few weeks of contribution in our Q1 '23. As you will see in our guidance from Anthony, we expect the integration and synergies from this acquisition to take place through FY '23 with the first full year of revenue and margin impact coming next year. Speaking of M&A more broadly, our total growth strategy is playing out as planned. We're sticking to our disciplined approach, finding great companies and adding great customers, employees, and products to our portfolio. Our capital structure and ability to finance new transactions is in excellent shape. We're selective, we're patient, and we're ready to find the next good deal. We're also executing our integration playbook well once we make acquisitions. We learn from each acquisition and continually incorporate better strategies and tactics. And we use our significant corporate development experience as well as our ability to walk away from transactions that don't fit our model to seek out good deals in a challenging M&A landscape. Most of all, we remain committed to our goal of providing strong returns to shareholders and allocating our capital in the most efficient and productive manner. And as you can see as good as fiscal '22 was, we're even more excited for fiscal '23. As I'm sure you heard in Yogesh's remarks, we're very pleased with our performance in the fourth quarter and the full fiscal year 2022, and we're also delighted to have signed a definitive agreement to acquire MarkLogic, which met all our M&A criteria and provides a larger-scale opportunity for significant value creation. Turning to the numbers, we'll start on the top-line with ARR, which we believe provides the best view into our underlying performance. As a reminder, our calculation of ARR is presented on a pro forma basis to include the results of acquired businesses in all periods presented, and in constant currency, with all periods presented at our current year budgeted exchange rates. ARR at the end of Q4 was $497 million, representing approximately 3.5% organic growth on a year-over-year constant currency basis. The growth in ARR was driven by multiple products including OpenEdge, DataDirect, Sitefinity, Chef, DevTools, and File Transfer. A consistent trend that continues to fuel our ARR growth is strong net retention with rates remaining at a record high in Q4, again, exceeding 101%. Revenue for the quarter was $159.2 million and represents 11% growth over the prior year, reflecting an incremental contribution from Kemp, which we acquired in Q4 of 2021, coupled with strong sales of our OpenEdge, DataDirect, Sitefinity, DevTools, and File Transfer products. It's also worth highlighting that on a constant currency basis, our year-over-year revenue growth for the fourth quarter increased from 11% to 15%. For the full year, revenue of $610.6 million represents 10% growth compared to 2021. This year-over-year growth is comprised of a full-year revenue contribution from Kemp and growth across multiple other product lines, most notably OpenEdge, DataDirect, and DevTools. Again, worth highlighting is the impact of exchange rates because revenue growth for the full year at constant currency would have increased from 10% to 12.5%, an approximately $17 million headwind from foreign exchange for the year. With customer retention rates remaining consistently strong throughout 2022 due to the strong demand environment fueling growth across our portfolio, we're thrilled with our top-line results for the year. Turning to expenses. Total costs and operating expenses were $97 million for the quarter, up 6% over the year-ago quarter, and $369 million for the full year, up 12% compared to the full-year 2021. For the quarter and the full year, the increase in costs and operating expenses was driven by an increase in our cost base resulting from the acquisition of Kemp. Operating income for the quarter was $62 million for an operating margin of 39%, compared to $52 million or 36% in the year-ago quarter. For the full year, operating income was $242 million for an operating margin of 40%, compared to $229 million, or 41% in 2021. Earnings per share were $1.12 for the quarter, an improvement of $0.20 compared to the year-ago quarter. And for the full year, earnings per share was $4.13, an increase of $0.26 compared to 2021. Moving on now to a few balance sheet and cash flow items. We ended the year with $252 million in cash, cash equivalents, and short-term investments and approximately $300 million in untapped capacity under our revolving line of credit for a total liquidity of $552 million. In addition, we had a debt balance of $628 million, which is comprised of our term loan in the amount of $268 million and $360 million in convertible notes. DSO for the quarter was 62 days compared to 60 days in the fourth quarter of 2021. The increase in DSO was driven by the timing of billings, with much of our billings' overperformance coming very late in the quarter. Deferred revenue was $282 million at the end of the fourth quarter, up $30 million from a year ago, a reflection of our strong year-over-year top-line performance. Adjusted free cash flow was $37 million for the quarter and $189 million for the full year. We repurchased $1.5 million worth of stock during the fourth quarter, bringing our total for the year to $77 million. As a result, at the end of Q4, we had $78 million remaining under our current share repurchase authorization. But as you've no doubt seen in today's press release, we've increased the amount available by $150 million, for a total of $228 million now available under our plan. Now I'd like to turn to our outlook for Q1 and the full year 2023. When considering our outlook, it's important to keep in mind the following. First, 2022 was a year of top-line growth in constant currency across many of our product lines. In 2023, we expect stability in the demand environment for our products. And as a result, our top-line guidance range reflects a relatively flat top-line for our non-MarkLogic product lines. Next, our expectations from MarkLogic and MarkLogic's contribution to 2023 are driven off an assumption that the deal will close during February of 2023, thereby contributing less than 10 months of MarkLogic's activity. Once integrated, we expect MarkLogic to be contributing more than $100 million for our top-line annually. It is important to understand that MarkLogic has a revenue model that is driven by [technical difficulty] which can result [technical difficulty] revenue. It is also very important to understand that MarkLogic as of January, 31 [technical difficulty] business, results in roughly one-third of all our private activity involved in [technical difficulty] we expect MarkLogic to contribute approximately $70 million of revenue to our fiscal 2023 and to deliver margin of approximately 25%. As previously mentioned, we expect the integration of MarkLogic will continue throughout 2023, and therefore, expect to recognize cost synergies gradually during the year and to exit the year with a fair margin from MarkLogic of more than 40%. We anticipate [technical difficulty] from our revolving line of credit to finance a portion of the MarkLogic purchase cost and while our [technical difficulty] leverage levels are expected to remain modest, increased interest rates will impact our borrowing costs, resulting in interest expense of roughly $0.20 per share associated with the MarkLogic revolver drawdown, and another increase in interest expense of $0.11 per share on our existing term loan A. The final point I'd like to highlight relates to Section 174 of the U.S. Tax Code and its anticipated impact on our 2023 cash flows. As most of you are probably aware, Section 174 of the code was introduced in the Tax Cuts and Jobs Act of 2017, and it's effective for Progress beginning in fiscal 2023. Section 174 requires us to capitalize certain R&D expenses for tax purposes, which previously would have been expensed as incurred. Although, we don't expect any meaningful change in our effective tax rate, we do expect to make $15.2 million of cash tax payments in 2023, specifically associated with the capitalization requirements of Section 174, unless it's, again, deferred, repealed, or otherwise modified. With that, for the first quarter 2023, we expect revenue between $157 million and $161 million. This includes less than one month of a contribution from MarkLogic. We also expect earnings per share of between $1.04 and $1.08. For the full year 2023, we expect revenue of between $675 million and $685 million, representing 11% to 12% growth over 2022. We anticipate an operating margin for the year of approximately 38% with a headwind from the MarkLogic integration which will improve through the course of the year as I've previously mentioned. We're projecting adjusted free cash flow of between $175 million and $185 million, which includes the $15.2 million in incremental tax payments associated with Section 174 of the U.S. Tax Code. And we expect earnings per share to be between $4.09 and $4.17. Again, this range reflects the previously mentioned negative impact from increasing interest rates of $0.11 per share on our existing credit facilities and $0.20 per share on the facilities we anticipate tapping into for the MarkLogic acquisition. Our guidance for the full-year earnings per share assumes a tax rate of 20% to 21%, the repurchase of $30 million in Progress shares, and approximately 44.4 million shares outstanding. Our share buyback activity in 2023 is meant to address dilution from our equity plans. And while we believe that share buybacks and dividends can provide shareholders with a good return, our M&A track record over the past three years has delivered superior returns for our shareholders, and for that reason, disciplined accretive M&A continues to be the top capital allocation priority of our total growth strategy. In closing, I'd like to reiterate that we're thrilled with our Q4 performance, the announced acquisition of MarkLogic, and our outlook for 2023. As Yogesh outlined, we believe we're well-positioned operationally and financially to continue executing our total growth strategy to create meaningful value for our shareholders. Hi, Sherry, it's Mike, and everybody, I know Anthony's audio was breaking up while he was giving the MarkLogic guidance. Sheri, if it's okay with you, can - Anthony, do you mind reading the part, again, what I sent? It's in your chat and also, it's the paragraph begins next to our expectations for MarkLogic, and it ends with the paragraph where we - where the last words are, the comments about the term loan A. Yes. So, we're going to start again and just go through the MarkLogic guidance, with the paragraph starts to next to our expectations from MarkLogic and MarkLogic's contributions, and then go right to the end where we talk about the term loan A. Yes. Okay. All right. So, I will go a take two. And next, our expectations from MarkLogic and MarkLogic's contribution to 2023 are driven off an assumption that the deal will close during February 2023, thereby contributing less than 10 months of MarkLogic activity. Once integrated, we expect MarkLogic to contribute more than $100 million to our top-line annually. It's important to understand that MarkLogic has a revenue model driven by term-based license agreements, which can result in uneven recognition of revenue. It's also very important to understand that MarkLogic has a January 31 fiscal year-end, and seasonality in the business results in roughly one-third of all MarkLogic activity being booked in December and January of any given year. Because of this seasonality, we expect MarkLogic to contribute approximately $70 million of revenue to our fiscal 2023, and to deliver an operating margin of approximately 25%. As previously mentioned, we expect the integration of MarkLogic to continue throughout 2023. Therefore, we expect to recognize cost synergies gradually during the year and to exit the year with an operating margin from MarkLogic of more than 40%. We anticipate drawing on our revolving line of credit to finance a portion of the MarkLogic purchase price. And while our pro forma net leverage levels are expected to remain modest, increased interest rates will impact our borrowing costs, resulting in interest expense of roughly $0.20 per share associated with the MarkLogic revolver drawdown and another increase in interest expense of $0.11 per share on our existing term loan A. It was. Thank you, Anthony. Sorry to throw that on you at the last second. Now, I think if you guys are good, Anthony, Yogesh, we can open up to Q&A? Hi, thank you, guys, for taking the question. One question for Anthony first on MarkLogic. The seasonality that you're talking about with one-third bookings in, I think you said December and January, how does the rest of the year flow? Is it very minimal in Q1 and it kind of goes through the year? Yes. I would say you're going to pick up. What we would see in the first quarter as a contribution is going to be minimal. And certainly, because we close during February, end of February is our Q1, and because so much activity gets booked in December and January, so, I think, spreading things relatively evenly over the remaining three quarters is pretty much a safe bet. I see. Okay. Got it. One question for Yogesh. I checked the MarkLogic's website. They were talking about an OEM partnership as well. What portion of the business is OEM-related? And it seems like they have a general SI channel. And now with Kemp, I guess, you have two companies with a broader SI channel. Would love to hear what - you were talking about the plans of kind of developing that broadly across the business, where do we stand today? Maybe help us give us an update on that. That's all from my side. Happy to do so Pinjalim. Thank you. The OEM business is relatively small for MarkLogic, as you know that in our DataDirect business, the OEM business is the lion's share. That's not the case in MarkLogic. MarkLogic does have an OEM business, but rather small. The SI part is really interesting because our relationships with SI started actually also in connection with Chef. Chef was sort of the first one where SIs have been playing a very important role in winning customers and helping customers be successful. And then that further expanded with Kemp, as you likely recalled, and then now it further helps expand that channel for us with MarkLogic. So, it is to me a really important channel as you're aware, system integrators do enormous amount of work in terms of making customers successful, having trusted partnerships with system integrators who are well-versed with products, who have certified folks on their teams, who know the products and can do wonderful things for the customers with them, who actually have a practice around products is truly beneficial. And so, we are happy that we're able to expand that relationship, Pinjalim. And again, the opportunity in my mind is really the key opportunity is to be able to go to somebody who is an SI for a particular product and have them do some work on other product. Just as an aside, by the way, we also have - and I - we don't call them SIs because these are - these guys do more than system integration work, we have digital agency ecosystem around our Sitefinity and the whole online presence with our product portfolio around building and developing and targeting and doing the online analytics for online customers. Then those digital agencies, they play a big role in the success of Sitefinity as well, which includes the part of those digital agencies also have some system integration capabilities as well. So, we actually are building a really solid SI ecosystem in addition to our standard go to market with our own business as well as the sort of the channel business, which is much more reseller distributor two-tier channel. So, we're really excited about that as well. Thank you. One moment for our next question. That will come from the line of Ray McDonough with Guggenheim Partners. Please go ahead. Great. Thanks for taking my questions. This is Ray McDonough on for John DiFucci. Yogesh, maybe to start, you mentioned that business was strong across all business lines, and I was hoping you could parse that out a bit. Was there anything in the portfolio that was a little softer than another? I'm thinking OpenEdge is probably more stable in this environment and maybe you're seeing more softness or even cracks in something like Chef perhaps. I'm just trying to get a sense for how the portfolio performs relative to each other, if that makes sense. Yes. So, thanks for asking, Ray. Actually, if you look at our business - and again, FX makes the - look business look different than really in constant currency it was, I mean, there was a significant amount of outperformance throughout the year. And it did come across pretty much the entire portfolio. I mean, you think about the - whether it is Chef or whether it is OpenEdge or whether it is DataDirect or Sitefinity and DevTools, if there's one product which I would say didn't show same level of outperformance, it's our network management product, WhatsUp Gold. And I think that's because in 2021, there was significant tailwind in the market because of what had happened to SolarWinds at the end of 2020. And as everybody knows, 2021 was a really turbulent year for SolarWinds and I think a lot of SolarWinds customers went looking for alternatives in 2021, which led to some additional outperformance on our part with WhatsUp Gold. And I think it's back to sort of more of its regular cadence that it had before that happened. So, I think that would be the only area where I would say we did not see the level of performance - really outperformance and strength that we saw across everything else. Great. Thanks for the color. And then maybe for Anthony, as I think about you taking on more leverage for MarkLogic, how should we think about the use of capital going forward to either pay down debt? And where - what levels are you comfortable at in terms of your net leverage if you see an attractive M&A opportunity in the next six months to 12 months where you really feel like you should be pulling the trigger, where do you think you feel comfortable bringing that leverage in light of a rising interest rate environment here? Yes. Ray, it's a good question. And I talked a little bit about the impact of increasing rates on the outlook for the year. But even having said that, I think with what we will draw down or what we anticipate drawing down from MarkLogic, I would expect the leverage levels sort of on a pro forma basis to remain well under three. I would expect that probably debt repayment will come into the calculus on capital allocation during the year. We'll do some a little bit of calculus on rates and other potential uses of capital. But I suspect we're going to want to pay down. And like I said, the drawdown is not so much. So, if we were to go up to say 2.5 times leverage on a pro forma basis, you'd probably see that under two as we go into 2024. So, I would expect that we start to de-lever from this one pretty quickly. And I think we'd be comfortable a bit, to do a deal maybe up at three times net. But, again, that's at a point in time to get a deal done and similar to what we would do with a deal like MarkLogic, we'd probably look to de-lever in a rate environment like this pretty quickly. Thank you. One moment for our next question. That will come from the line of Fatima Boolani with Citi. Please, go ahead. Hi. Good afternoon. Thank you for taking my questions. And Happy New Year. Yogesh, I'll start with you. There was a cyber incident at the firm, and I understand you're taking a couple of charges just with respect to that incident. So, I'm curious if you could just expand upon that a little bit and - to the extent that lead you up and margins maybe creating a little bit more - maybe a little less stability, if you will, in terms of the growth expectations for the non-MarkLogic portfolio. And then I have a follow-up for Anthony, if I could, please. So, as you are aware, and I think as we have mentioned before, the investigation into the incident is still open and ongoing. So, we really can't comment on it any further other than basically we've said before, and we can reiterate that we do not expect any material impact to our business, operational, financial results, etc. From a product-specific perspective, I don't see there - this causing a product-specific impact, otherwise we would have talked about it, right? So, I don't think that the growth aspects of our projections for FY '23 are related to that. As Anthony mentioned, right, the - we're expecting stable revenues this year from the base products. Obviously, 2021 and 2022 saw some phenomenally wonderful demand for us. And I think the overall macro is slightly different or maybe hugely different depending on what you think, right? And so, we are being very straightforward about the fact that, yes, we expect there to be stability in our business this year rather than significant growth. We do expect ARR to grow, by the way, Fatima, right? So - and we said that we do. And we'll expect it to grow modestly. And we think that our core business is truly solid across the board. Fair enough. Anthony, just shifting gears to the cash flow. I appreciate some of the commentary you've shared about some of the tax and regulation changes on R&D expensing. But I wanted to ask about potentially other impacts of the cash flow inclusive of, if there is a linearity or collections consideration for MarkLogic. And then just generally, I think you called out sort of back end loaded performance. So, just curious as to why you did see linearity shift to the back end of the quarter and how that should sever into our cash flow expectations, considering the R&D expense and dynamic and potentially what we need to stay mindful of on MarkLogic's impact to the cash flow. And that's it for me. Thank you. All right. Yes. So, there's a lot there sort of packed into that question. And I guess, the largest item in terms of the '23 cash flow to call out, really is that $15 million in incremental cash payments that we'll make under Section 174. And like I said, it doesn't affect our rate in any meaningful way. So, it really just is an acceleration of cash out to the IRS. So, that has an impact in '23. I think MarkLogic, for sure, when they're booking, let's say, a third of the business in December and January, that certainly will impact sort of the linearity or seasonality of cash flow. We won't realize the benefit of that, I think, until we roll into to next year into our fiscal '24. But certainly, along with the top-line seasonality and the amount of activity that's packed into December and January, we should see something similar from a cash flow standpoint. And then the last comment, I think, that you were sort of driving at was the [technical difficulty] year-over-year for the fourth quarter and now we've had pretty good [technical difficulty] looking for. Thank you. One moment for our next question. And that will come from the line of Harshil Thakkar with Oppenheimer. Your line is open. Great. Thanks for taking the questions. So, Yogesh, you've talked about previously how there are parts of the portfolio that kind of operating these price-competitive markets where you're a bit careful on conducting price increases. And then there are other parts where you'll be a bit more proactive. Can you just describe where you think MarkLogic fits within that spectrum and how we should be thinking about price increases for that business going forward? And then as you look at the renewal pipeline for 2023, how are you thinking about price increases there? Yes. Absolutely, Harshil. Happy to do that. So, Harshil, again, MarkLogic has by and large a business that, as Anthony mentioned, is multi-year term licenses that renew, let's say, three years at a time of somewhere in that range. And so, you end up with, again, only about a third of the business coming up for renewal in any given year. So, that's point number one. Point number two`, based on what we know, and our due diligence, the - not every one of their contracts has the ability to have meaningful price increases in it. As you know, they have a significant government business and there are limits to how much you can do in terms of price changes with the government - federal government contract. So, it is - again, it is, I would say, given the fact that it is only about three quarters of the business in terms of three fiscal quarters, given the fact that it's only about 70% or even slightly less than 70% of their overall business and the one third of the business doesn't come in, in FY '23, and given the fact that only about a part of the business will be up for renewal, I don't think it is a very large number. I would say, maybe on an annualized basis, it would be about 20% of their revenue for MarkLogic, where I think there's an opportunity to do some price increases. The product is very strong and is excellent. So, I think in those cases, we may be able to do some reasonable price increases. Again, the goal, Harshil, for us is customer retention matters more than the actual price increases. So, that's our philosophy. It has always been. And we will continue to focus on that. Going back to the rest of our portfolio, again, oh, gosh, about, I think going back to this, right, that more than a third of the business - of the core business, pre-MarkLogic business that Progress has, is such that it's OEM and - or it is based on sort of royalties or revenue-sharing, etc. So, those things, there are really no price increases that are in our control. Where there is price increase opportunity, obviously, in across two-thirds of the portfolio as you yourself said, right, there are some products that are extremely competitive markets where we don't see much either, so - much opportunity either. So, that leaves probably about half our business. And in about half our business, maybe somewhat less of our original business, again, you're looking at sort of three-year renewal cycles. So, you can do the math yourself and you end up with, again, less than sort of 20% of our overall revenue, you can have some price increase. So, overall, by the way, Harshil, price increases are not a big component of our business stability. Our business stability is primarily driven by the fact that we have very, very high - and an increasing, by the way, right, gross retention rates. We - every single acquisition we do, or we have done so far, we have increased the gross retention rate, and thereby increased the net dollar retention rate as well. And so, to me, that's sort of what drives the stability in the business. And one moment for our next question. And that will come from the line of Anja Soderstrom with Sidoti. Your line is open. Hi. Thank you for taking my questions. Lot of my questions have been addressed already. But I'm just curious after sort of bidding your guidance for the year, you're coming in at the lower end. Was there anything in the fourth quarter that sort of surprised you? Not really. We had a solid fourth quarter. We were within our guidance for revenue. We were above our guidance for EPS. I think, Anja, we had a solid quarter. I do think that we executed well. Again, Anthony, I don't know if you have something you want to add. Yes. I would just say that we - coming into the fourth quarter, we probably left our range on the top line a little wider than we might otherwise. And the reason for that was because we were just whipsawed on foreign exchange rates last year, like a lot of companies were. And so, there was a bit of uncertainty going into the fourth quarter about how that would all land. So, the range might have been a little bit wider than would have ordinarily been the case. But to Yogesh's point, otherwise, it was, from our perspective, just solid across the board. Okay. Thank you. And I'm just also curious for the MarkLogic with the term-based licenses. How long are the duration of those? Are those one-year contracts or... Yes, a lot of multi-year. So, I'd say, yes, a lot of three-year contracts, some longer than that. But by and large, we end up with a lot of multi-year term-based license deals. Thank you. One moment for our next question. And that will come from the line of Brent Thill with Jefferies. Your line is open. Hi, guys. It's [Antonio] on for Brent here. Thanks for taking the question. About 20% of your revenue is invested back in R&D. And I was just wondering if you could talk a little bit about where those investment dollars are going. I'm wondering that you guys are working on now. And then maybe some key points you'd like to highlight for us. Yes. So, Antonio, the - as we've said before, right, that our - we have a tremendous emphasis on customer retention. And so, the question becomes, what can you do to drive net dollar retention of your customers and retain them and expand business with them and continue to build with that, right? And so, we actually basically spend and invest more in R&D to make sure that our products stay ahead of the curve that - and this is across the board, right, this is across our portfolio, to make sure that our customers stay with us because it's much, much easier, much, much cheaper for us to retain customers that way than to win new ones. And so - and of course we spend significantly less, again, relatively speaking, on sales and marketing, which is why if you look at our overall operating margins, they truly are world-class, right? A company our size and scale in the software industry just doesn't have the percentage operating margin that we do and the kind of cash flow generation that we do. So, I think that, to me, it becomes - and to us, it becomes very much a question of where do you put in your dollar to invest with shareholders. And we believe that investing in the product side is much better than trying to not invest in the product side and then try to clean up with all the other effort that would be needed. And so, that's where we invest, and we continue to look for the right level of investments to continue to make sure that our products are leading edge. And it really is across our entire portfolio. Awesome. Thanks for that. And maybe one quick follow-up or more of a clarification. I think you mentioned Kemp in your opening remarks. But where are we with that acquisition? I know you have to integrate Kemp and Flowmon together. Are we done with that or is there still a little more work to be done? No, yes. I mean, we are done integrating Kemp. I think I might have said that in the opening remarks as well. Our integration of the Kemp business, both the products, Kemp and Flowmon products, and the business is complete. They are a key part of our infrastructure management portfolio, and they are - they have been integrated on our platform. And we're now looking forward to closing the MarkLogic deal and beginning that integration. Thank you. One moment for our next question. And that will come from the line of Ittai Kidron with Oppenheimer. Your line is open. Hi, guys. I just want to follow up on a couple of financial things, Anthony. First on the - on MarkLogic. Can you talk about how you're going to incorporate them in ARR since they're so lumpy? What is the financial exercise you'll do to normalize that into an ARR number? Yes. Sure, Ittai. I think we would expect that once the deal closes and we get to Q1, we would incorporate all of the ARR. So, we would effectively be able to provide [technical difficulty] So, Ittai, let me try to repeat what Anthony was saying, just to see if - so you can hear it this time around. So, basically, as you know, when we complete - I mean, when we close the deal, then in the first reporting period which would be at the end of Q1, we basically take the historic ARR of that business and we do a pro forma across the history and current, and we use that going forward. Of course, for multi-year term licenses, we analyze those. Obviously, the maintenance becomes - or any other recurring revenues is annualized, of course. So, what we would expect to do is we would expect about $75 million increase to show in the ARR once the deal closes. And then we expect the ARR from MarkLogic to continue to grow. We have seen a steady growth in the ARR over the last three years, and we expect that trend to continue. Okay. And then last one for me, on the revenue guide for the year, when you take out MarkLogic from this exercise, and I assume that your guidance for '23 includes already the $675 million to $685 million, does that include or does not include MarkLogic, just to be clear? Includes? So, if you exclude your comments on MarkLogic from that number, you're basically guiding a shortfall of about $20 million roughly plus, minus on the year. Can you talk about break that down a little bit more, say, as to the components of that, and what is your underlying macro assumption that you've taken into account in your guide? No. We're actually guiding, Ittai, if you were to take out $70 million, I think you'd be showing, and also if you factor in, say, I think $1.2 million in exchange rates that we mentioned, you'd be showing a little bit of growth at the midpoint. I mean, it would be slight, but growing a little bit. And I think from a macro perspective, that's sort of leads to the consistency we talked about in terms of what we're seeing in the demand environment. Thank you. I'm showing no further questions in the queue at this time. I would now like to turn the call back over to Mr. Yogesh Gupta for closing remarks. Well, thank you, again, everyone, for joining for the call. And we look forward to speaking to you again soon. Thank you and have a good night.
EarningCall_1440
Good morning, and welcome to the Ocean Power Technologies Second Quarter Fiscal 2023 Earnings Conference Call. A webcast of this call is also available on the company's website at www.oceanpowertechnologies.com. This conference call is being recorded and will be available for replay shortly after its completion. On the call today are Dr. Philipp Stratmann, President and Chief Executive Officer; Bob Powers, Senior Vice President and Chief Financial Officer; and Joseph DiPietro, Controller, Treasurer, and Principal Accounting Officer. Following the prepared remarks, there will be a question-and-answer session. Thank you. After the market closed yesterday, we issued our earnings press release and filed our quarterly report on Form 10-Q for the period ended October 31, 2022. Our public filings are available on the SEC website and within the Investor Relations section of the OPT website. This call will include forward-looking statements that are within the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may include financial projections and other statements of the company’s plans, objectives, expectations or intentions. These statements are based on assumptions made by management regarding future circumstances over which the company may have little or no control and involve risks, uncertainties and other factors that may cause actual results to be materially different from any future results expressed or implied by such forward-looking statements. Additional information about these risks and uncertainties can be found in the company's Form 10-K and subsequent filings with the SEC. The company disclaims any obligation or intention to update the forward-looking statements made on this call. Finally, we posted an updated investor presentation on our IR website. Please take a moment to review it as it provides a nice overview of our company and strategy. I'm pleased with our progress on building our order book and sales pipeline were up $2.9 million of orders, which is nearly 6x what it was at the same point last year. We remain on track for our $9 million audit target over the year as we continue to build our pipeline of feasibility studies, demonstrations and future orders. Our most recent win has been the demonstration we're doing in Bahrain to show the effectiveness of autonomous vehicles when they're used in combination with PowerBuoys and our proprietary MDA software. We just completed this demonstration and are actively discussing next steps in support of a digital horizon exercise. We had a nice quarter of steady progress on each component of our stated strategy which is working. From a high level, we provide autonomous ocean intelligent solutions. These can be roaming or stationary and are usually powered by renewable energy. Our systems offer benefits to customers across multiple governmental entities, as well as customers in the commercial space. Whether it is protecting offshore operations, gathering ocean intelligence, or supporting offshore developments. We reduced carbon footprints and lower operational expenses. Specific to our strategy, first, we have data as a service, where we had a good quarter on our pipeline of order activity of WAM-Vs. We also made progress on our MDA solution which is now available commercially and as expected to begin to generate revenue in the second half of this fiscal year. We believe it is the start of a game changing aspect to our business. We continue to get the most interest from divisions of the government and we believe we're building a strong recurring customer base. As mentioned last quarter, we are working with the U.S. Department of Energy and the Phase 2 development of next generation wave energy converter. Specific to this project, we received the $1.1 million payment in the quarter, which is intended to be used to develop and test a modular and scalable Mass-on-Spring Wave Energy Converter PowerBuoy over the next 24 months. This amount is included in the year-to-date order activity I referred to earlier. I would like to take a moment to make a few comments about our autonomous vehicle division. This division came to us via acquisition back in November 2021. So a little over a year ago. I could not be more pleased with the management team and the efforts to integrate the business with ours. Most notably, we're close to fully consolidating the manufacturing operations to our facility in New Jersey. This will make us faster and be more cost effective. We continue to seek opportunities to expand our customer base, mostly in the government sector and oil and gas industry. Second is Power-as-a-Service. During the quarter, we continue to have solid activity related to this component, especially with inquiries on leasing as opposed to owning. We will continue to like our move in this direction, since it brings the upfront investment level down significantly for our customers. In addition, we're having good success to-date by pairing our PowerBuoys with our WAM-Vs and we expect this trend to continue going forward. Third, is our strategic consulting services. We had another good quarter of activity related to consulting, especially around simulation engineering, software engineering, concept design, and motions monitoring. In short, I like the energy I'm seeing throughout the organization. We continue to position the company well with the industries we serve and our chosen verticals. I'll start with revenue. For the quarter, our top line was $303,000, which compares favorably to the $247,000 in the prior second quarter. Year-to-date our revenue generation is nearly 2x, where we were last year. As Philip indicated, our orders are at $2.9 million year-to-date and growing. We continue to expect order activity and revenue to ramp meaningfully throughout the second half of the year. In terms of deferred revenue, our deferred contract liabilities are up $1.4 million in the quarter, most of which is related to the 1.1 million advance payment received in the MOSWEC buoy under development. I expect this to be recognized as revenue over the next 24 months as the project takes place. We are managing our COGS well. So far, we have had minimal issues with our supply, and we expect this to continue. Our parts materials are available when we have adequate inventory to continue to ramp up production, especially of WAM-Vs. With our established WAM-V business and the continued growth of our higher margin strategic consulting business, we expect to build gross margin going forward. Moving to our cost structure, we continue to manage costs well. Our operating costs inched up sequentially by less than $100,000 in the first quarter and are now at $6.4 million. This includes our engineering and product development costs and our G&A. From a high level, we expect our revenue growth rates to far outpace our operating costs. Over the next few quarters, we expect similar movement in our cost structure, as you saw in the second quarter. One final income statement item of note is the $1.2 million of other income in the quarter. This relates to the employee retention credits we apply for with the IRS in the second quarter for tax returns that we filed in 2020 and 2021 during COVID, when stay-at-home restrictions were in place. You can see a corresponding increase on our balance sheet and accounts receivable. We started to receive payments in November and expects full payments by the end of fiscal 2023. This is great work by our team to make this happen. Moving to our balance sheet. We ended the quarter with $46.2 million of combined cash, cash equivalents, restricted cash and short-term investments and no bank debt. Our year-to-date net cash used in operating activities was $11 million for the period and plus a quarterly run rate in line with the past few quarters. From a financial perspective, we had a steady quarter. We are maintaining strong oversight of our costs and positioning our company for top line growth. Thank you. The floor is now open for questions. [Operator Instructions] The first question today is coming from Shawn Severson of WTR. Please go ahead. Could you expand a little bit on the trip to Bahrain and the digital horizon? Specifically, I'm trying to figure out kind of what's your -- what did you learn there from what you were seeing from them and what they were looking for. And then, second of all, what would be the next steps there, I'm trying to figure out? Are we in like the third inning here, the seventh inning for some type of deployment or getting towards material orders? That's great, great questions. Thank you, Shawn. Certainly, we’re very proud and humble to be able to support the U.S. Navy in its efforts to increase its autonomous and artificial intelligence capabilities starting through Fifth Fleet in the Middle East and what plans U.S. Navy may have after that. We were one of several participants that was out there. We had three of our assets deployed during digital horizon, including several long duration deployments that we carried out that went in excess of 24-plus hours. And we continue our discussions now on what this may mean in terms of next deployments that will go on. You've probably seen the public statements that U.S. Navy has made through Central Command and General Kurilla, who stated during the Manama dialogues in Bahrain, I think, it was the weekend before Thanksgiving, the plans for the Department of Defense are to have 100 USVs deployed in the region, by the summer of 2023. We obviously applaud and congratulate U.S. Navy on that approach and increasing its autonomous footprint. And we look forward to supporting it, whichever way we can. If you look at the deployments that we've been doing and demonstrating during digital horizon, it's very similar to some of the other work we have done previously and build upon the abilities that we have developed as part of our proprietary maritime domain awareness solution. You get into the realms of supporting oil and gas companies and other offshore energy companies with monitoring of ocean areas on the surface. It quickly expanded into areas that are similar to what we are doing for EGP down in Chile, where we're doing subsea monitoring and water quality sensing. And then that obviously extends into illegal fishing and monitoring of protected areas. And quite frankly, infrastructure assessments in harder to reach areas where you're trying to remove operator out of arms way. And the last question is on R&D roadmap. So I think talk specifically about the MDA solution will be helpful, but also bigger picture question. When you look at where you need to spend, watch or spend, emerging technologies, sort of commercializing technologies, can you just walk through framework of what you're working on and where the spend is going to be in priorities? And again, I'm particularly interested in that next round of MDA as well. Sure. I mean, MDA, we are offering and discussing it with commercial customers right now. But obviously, it’s being a technology-based solution, there's ongoing development that we do for additional user features, additional integration of other sensors that we didn't have before, and so on so forth. Our primary focus is not on coming up with the next thing, but combining the current technologies that we have into a holistic offering, that gives our customers the ability to utilize roaming and/or stationary assets that can be combined with surface and subsea monitoring equipment, without having to kind of needed to pick and choose amongst a whole range of companies, but rather offering them a one stop shop of an integrated solution that can be as integrated or as diverse as they may require for their solutions. So this isn't so much looking for next gen, let's call it leading edge technology. This is really becoming its commercializing solutions at this point using the portfolio of technology. Is that what I'm hearing? Absolutely. We have a robust set of platforms. And obviously, we will continue to work on improved user features and additional features we can integrate into it. And we are continuing the development of the next generation mass-on-spring wave energy converter, which we’re working together with the DoE under the grant funding that we have received to utilize that. But generally speaking, the primary effort is on getting a holistic set of assets out into our customers’ hands that can easily collaborate and work with each other. Good morning. Philipp, first, I just want to ask what are the expected benefits of the MOSWEC PowerBuoy versus the current solutions? Thanks, Jeff. Good morning and thanks for joining us. The PowerBuoy that we have right now is entirely fit for purpose. What we are looking at and similar to what I mentioned to Shawn is having a seamless, consolidated offering in the marketplace. By finishing the development of the MOSWEC system, we'll be able to start consolidating whole shapes when it comes to the buoy platforms, which will give us the ability to have one common whole shape, whether you're using -- with a wave energy converter or without a wave energy converter, as we have done in the past with hybrid, thus further streamlining the offering and making it more cost efficient for our customer base. And do you anticipate there being any manufacturing benefits from that as well, maybe in terms of internal costs for the company? Absolutely. If you think about the supply chain benefits of moving to a common whole shape across all of the buoy systems, you can start – you rapidly start being able to scale up, raw materials sourcing, you start consolidating working on [WIP] [ph] assets. And obviously, it becomes much easier to install the finished goods side. So there's a whole bunch of benefits that come from the consolidation of efforts as opposed to just the “benefit” of a common whole shape for the customer. And I was wondering, can you provide us with any kind of sense of what the revenue implications might be at USV sales, if you get some meaningful portion that USV stated desired by the Navy in 2023? Yes. So as stated, we feel comfortable with the 9 million booking forecast we put out for the current fiscal year, and we will work on expanding that for the next fiscal year. And I think the interest that we're seeing in the market and the broader demand picture is giving us comfort that our sales team and commercial team can start concentrating on converting opportunities into additional orders and backlog. Well, without asking for too much specificity, and should I take from that, that the 9 million estimate that's on the books contains both commercial sales and forward payments of development projects, and - but also some military sales as well. Yes. I mean as we are seeing with the efforts that we've got ongoing, currently on a digital horizon and the work that we've discussed previously, that we've been doing for Naval Postgraduate School, we look forward to having a robust pipeline that contains a healthy mix of government and commercial orders and government being the defense and national security space, as well as efforts around in non-defense spending on the government side. And my last question is, with regard to the oil and gas business, where we're generally led to believe that offshore oil and gas development is due to be fairly static over the next future years. There can be a few exceptions, like ExxonMobil, offshore Guyana, but in general, fairly static. So I'm wondering what areas of application you find that you believe you can grow into the industry, even as it itself seems to be sort of consolidating and pulling that? Yes, I think we will continue. As I mentioned, we will continue to support our oil and gas and [solar] [ph] energy with large customers in the offshore world with solutions around monitoring of leased areas surface and subsea. As we've previously stated, we can support decommissioning efforts and well monitoring. And those specifically on the oil and gas side, our efforts will continue to pursue from an opportunistic standpoint. Thanks. Phil kind of a quick follow up question. How will you be looking at in-house maybe the government looking at maintenance on a product like this? So when you're talking about an infield deployment? How would that power maintenance be taken care of, would you train them to do this, or do you envision them deploying and it's a bigger picture question to not just for that, but bigger rollout of maintenance and service things that you need [indiscernible] for? Yes. I can't directly comment on how each individual agency, or a division of the government is going to deal with maintenance, specifically. The way we look at it and this itself, we've mentioned this before, similar to data-as-a-service. Also, on the vehicle side, we've been offering robotics-as-a-service for a while. So we will provide operators that can support the onboarding, and in service training of our systems, with our customers. And if there is a desire by the customer, to maintain that service, we will obviously maintain that service. And, equally, if there's a desire by our customer, specifically in certain spaces of the government to move into maintenance and servicing by that agency or service itself. We will provide a train the trainer approach, where we will support and upskill the government and then provide, spare parts and logistics maintenance as and when is required going forward. So, my last question is regarding the customization of the big data, big data size, very interesting, obviously, subscription business. How much can you manage and customize what you're looking for, I'm assuming it's a function of this instrumentation, right, what you're putting out on there. So if you know that there's a big demand for service a, you can equip them with the correct instruments and be able to provide that service. But I'm just trying to understand how do you figure out what you -- how you commercialize, and what do you market to potential customers for big data? So on the proprietary side, obviously, we have our maritime domain awareness solution, which at the moment, at the propriety part of that is primarily surface surveillance, intelligence and reconnaissance focused. But as long as it fits within the power budget, I mean, we've stated this before, we're sensor agnostic. So when to the extent that anybody wants to integrate other sensors into it, be there surface or subsea, we will accommodate any of those customer requests. We obviously collecting a large amount of data from our deployments that we have internally, and to the extent where customers allow us to retain some of the data that we can collect from deployments that we were doing on behalf of others. And so yes, and we continue to use that data to refine approaches and provide additional insights to the customer base as we scale up and continue rapidly scaling up the deployments that we have globally. Hey, guys. Just a quick question on the projected 9 million of revenue, will you be cashflow positive, with potential 9 million of revenue? Thanks, John. I appreciate the question. The 9 million of bookings that we are forecast for the current fiscal year are forming the basis of further growth. As Bob mentioned, during our earnings announcement, we're continuing to manage our SG&A and our margins in general. And we will be building on the 9 million which will put us on a solid path forward to achieve cashflow positive operations going forward. So the delay in the annual meeting is very straightforward. It was simply the fact that we were about 1 million votes short for quorum. Our corporate bylaws dictate that at least 50% of our shareholders to have their say, on the items we put to vote, and we were a million -- just about a million votes short of that, we've got just under 56 million shares outstanding. And yes, we’re just slightly short of the quorum. So we are giving our shareholders an opportunity to continue putting their votes in for or against the proposals that we've put out there and reconvene on January the 13. Thank you. We're showing no further questions in queue at this time. I'd like to turn the floor back over to Mr. Stratmann for closing comments. Thank you. We appreciate you joining us. I hope you can sense that our company is headed in the right direction. Thank you for being shareholders or potential shareholders of our company. Wish you a great holiday season and look forward to future updates. Have a great rest of your day. Ladies and gentlemen, thank you for your participation. This concludes today's event. You may disconnect your lines and log off the webcast at this time and enjoy the rest of your day.
EarningCall_1441
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 Walgreens Boots Alliance First Quarter 2023 Earnings Conference Call. [Operator Instructions] Good morning. Thank you for joining us for the Walgreens Boots Alliance Earnings Call for the first quarter of fiscal year 2023. I'm Tiffany Kanaga, Vice President of Global Investor Relations. Joining me on today's call are Roz Brewer, our Chief Executive Officer; and James Kehoe, our Chief Financial Officer; Rick Gates, Senior Vice President of Pharmacy and Healthcare at Walgreens will participate in Q&A. Today's call will be approximately 1 hour in length, including Q&A. Let me note that all references to the COVID-19 headwind include U.S. vaccines, drive-thru tests and OTC tests. As always, during the conference call, we anticipate making projections and forward-looking statements based on our current expectations. Our actual results could differ materially due to a number of factors, including those listed on Slide 2 and those outlined in our latest Forms 10-K and 10-Q filed with the Securities and Exchange Commission. We undertake no obligation to publicly update any forward-looking statement after this presentation, whether as a result of new information, future events, changes in assumptions or otherwise. You can find our press release and the slides referenced on this call in the Investors section of the Walgreens Boots Alliance website. The slides in the press release also contain further information about non-GAAP financial measures that we will discuss today during this call. Thanks, Tiffany. And good morning, everyone. WBA entered fiscal 2023 with good momentum, and we delivered a solid start to the year. Sales grew 1% in constant currency or over 3%, excluding the headwind from AllianceRx Walgreens and tailwinds from our new healthcare assets. The decline in adjusted EPS comes against very strong growth of 53% last year and reflects the anticipated headwinds from lapping COVID execution and our investments in the U.S. Healthcare segment and labor. Our core business remains resilient despite historic macro challenges. We are driving healthy retail comp growth on top of record prior year performances. Our script volume growth is on track with plan as our restaffing and marketing initiatives are gaining traction. We made an important announcement on our opioid legal matters in November, reaching an agreement in principle to pay approximately $5.7 billion over 15 years to resolve a substantial majority of our opioid-related litigation brought by states, political subdivisions and tribes. This allows us to move forward and focus on our purpose, helping consumers lead more joyful lives through better health. We are making great progress to accelerate our transformation to healthcare, most notably in the quarter with the VillageMD acquisition of Summit Health. At the same time, we're unlocking value and strengthening the company by simplifying the portfolio. Our execution to date reinforces our confidence in achieving our full year guidance for adjusted EPS of $4.45 to $4.65. We are raising our sales guidance, and we have greater visibility toward the strong 8% to 10% core growth that underpins our results, offsetting the COVID headwind of 16% to 18%. We are quickly scaling U.S. Healthcare with a defined path to achieve profitability exiting this fiscal year. Our strategic actions are working to create sustainable shareholder value as we reimagine local healthcare and wellness for all. We are making progress against each of our four strategic priorities. U.S. and Boots UK retail comp sales were both strong, with the U.S., excluding tobacco, up over 2% on top of almost 12% last year and boots up 9% on top of 16% last year. I am especially pleased with this good performance against a tougher consumer backdrop. The convenience and value that we offer are resonating well, and our initiatives to align the core are driving traffic and margin expansion. Walgreens launched 24 hours same-day delivery, offering the widest range of retail items for around-the-clock delivery across the country. This adds to our broad range of channel access, including 1-hour delivery and 30-minute pickup. The Boots consumer responded very favorably to holiday campaigns and promotions delivering record Black Friday online sales. Boots.com was one of the UK's top 10 most visited retail website on that day. And we're maintaining price positioning versus competitors and benefiting from inventory availability through our proactive buying ahead of this year's cold, cough and flu season. In the pharmacy, our team members administered over 8 million COVID-19 vaccinations in the quarter against our goal of 16 million for the full year. Walgreens has been a leading contributor to the national pandemic response with the study from the Commonwealth Fund showing that total industry efforts have prevented 18.5 million hospitalizations, saved 3.2 million patient lives and prevented 120 million COVID infections. This adds up to an estimated over $1 trillion in medical cost savings through the U.S. vaccination program. I could not be prouder of our pharmacy team's tireless execution being among the most trusted health resources available. We continue to care for our local communities and countless ways and we are focusing investments to return stores to normal pharmacy operating hours. Pharmacy staffing has been positive nearly every week since mid-July, and we are leveraging our digital platform to reconnect on a personal level with customers. Our efforts are on pace, resulting in over 2% comp script growth excluding immunizations in the quarter, up 220 basis points sequentially. Importantly, we are seeing mid-single-digit growth in stores with normal hours. We have also opened our ninth automated micro fulfillment center, now supporting about 3,000 total stores. These facilities remove routine tasks and excess inventory from the pharmacy supporting our team and the path to script recovery. They give pharmacists more time for services and outreach that drive adherence and improve patient health. Turning to our second strategic priority. This was a landmark quarter for accelerating the build-out of our next growth engine, the U.S. Healthcare segment. We invested $3.5 billion to support VillageMD's acquisition of Summit Health, creating one of the leading independent provider groups in the country. We recognize the critical importance of scale in value-based care delivery and density in attractive markets. This highly strategic transaction expands VillageMD's addressable market with primary care, multi-specialty and urgent care and reinforces our approach across the care continuum. We see meaningful synergy potential over time. The deal is also immediately EPS accretive and accelerates profitability for U.S. Healthcare. We expect to exit fiscal '23 with positive adjusted EBITDA. Shields Health Solutions and CareCentrix continue to perform well, which led to the accelerated acquisition of both entities. Shields closed on December 28, and CareCentrix is scheduled to close in the third quarter of fiscal '23. VillageMD is leading the way in value-based care for the country, with 393 clinics as of year-end, including 200 co-located with Walgreens, achieving the calendar 2022 target. Following the close of the Summit transaction earlier this week, VillageMD now operates over 680 locations across 26 markets. We also exceeded our goal for Health Corners with 112 now versus the 100 we had expected by the end of December. Our healthcare strategy is coming to life through all of our best-in-class assets, which drove a combined 38% pro forma sales growth in the quarter. This growth is funded through actions we continue to take to better align our investment portfolio and simplify the business. In November and December, we unlocked $3 billion in after-tax cash proceeds from the sale of 19 million AmerisourceBergen shares executing with tight discounts and near 52-week highs. We also realized approximately $150 million in proceeds from the sale of our stake in GPC. Lastly, we have a strong team that is fully aligned with our strategy, including a new structure for U.S. Retail Pharmacy and John Driscoll, leading U.S. Healthcare. Perhaps most crucially, we are continuing to invest in our people, to recruit and retain the very best talent, which is key to providing a superior customer experience. Fiscal '23 includes further investments in our pharmacy team and minimum wage, as previously stated. We're also reinventing the role of the pharmacists through micro fulfillment centers and eliminating task-based metrics, further enabling them to practice at the top of their license, while creating a differentiated work environment. Our retail pharmacy business provides the foundation for our leading healthcare assets to deliver value across the full care continuum. We are able to unite digital and physical models to guide consumers through the complex healthcare landscape. We are building the scale and resources to help health plans and patients improve outcomes and lower cost as only Walgreens can do. There are significant opportunities for synergies, allowing us to pursue value-based care and risk arrangements, which will demonstrate the value of an integrated approach. We are focused on expanding our risk business supporting integrated care models, expanding our pharmacy value proposition and driving operational efficiencies. I'm looking forward to sharing more with you ahead. Thank you, Roz, and good morning. In summary, we had a solid start to the fiscal year. Despite the expected headwinds, the first quarter results were broadly in line with our expectations, and we are maintaining our full year EPS outlook. Adjusted EPS of $1.16 declined by 29.9% on a constant currency basis as we were lapping a very strong prior year quarter when we delivered EPS growth of over 53%. The year-over-year decline was mainly due to a 19% headwind from COVID-19, U.S. Healthcare growth investments of 5% and labor investments of 5%. These were partly offset by good retail performance in both the U.S. and International segments and a favorable tax rate. Excluding AllianceRx and U.S. Healthcare M&A, sales grew 3.2% on a constant currency basis. The core business remained resilient in a challenging operating environment. Comparable sales were up 3.8% in the U.S., despite lapping a very strong prior year comp of 7.9%. International sales grew 4.6% led by the UK and Germany. And our U.S. Healthcare business continues to rapidly scale with almost $1 billion of sales in the quarter and growing 38% on a pro forma basis. With the first quarter broadly in line, we are maintaining our full year adjusted EPS guidance of $4.45 to $4.65 with 8% to 10% constant currency core growth offset by a COVID-19 headwind of around 17 percentage points. Our guidance now includes the EPS accretion from Summit Health and dilution from our reduced ownership stake in AmerisourceBergen. We have raised our full year sales guidance by over $3 billion to reflect the closing of the Summit Health transaction, refreshed currency rates and a good start to the year. Let's now look at the results in more detail. Sales of $33 billion rose 1.1% on a constant currency basis. Despite an adverse impact of 485 basis points from the anticipated decline at AllianceRx. This headwind will stop after December. Adjusted operating income declined 42% on a constant currency basis due to three factors. Firstly, a much lower contribution from COVID-19 vaccinations and testing led to a negative impact of approximately 20%. Secondly, the U.S. Healthcare adjusted operating loss was $139 million higher in the quarter, with an impact of 8 percentage points. The current quarter includes higher Walgreens Health organic investments and a full quarter of results for VillageMD compared to only 6 days of losses in the prior year quarter. Thirdly, our previously disclosed labor investments in pharmacy staffing and minimum wage, are a $100 million headwind, equivalent to 6 percentage points of AOI growth. Adjusted EPS was $1.16, a constant currency decline of 29.9%, due entirely to operating income. This was despite a favorable tax rate which benefited from the release of valuation allowances related to capital losses. GAAP earnings were a loss of $3.7 billion compared to net earnings of $3.6 billion in the year-ago quarter. The current quarter included a $5.2 billion after-tax charge for opioid-related losses, partly offset by a $900 million after-tax gain on the sale of AmerisourceBergen shares. Additionally, we are comparing to a prior year quarter that included a $2.5 billion after-tax gain on the company's investments in VillageMD and Shields. Now let's move to the U.S. Retail Pharmacy segment. While the U.S. performance was impacted by the anticipated COVID-19 headwinds, we do expect year-on-year performance to improve in the second half as the COVID headwind lessens and initiatives to drive script volume gain traction. Sales decreased 3% in the quarter, but if you exclude the negative impact of Alliance Rx, sales increased by 3%. The comp sales increased 3.8% despite lapping a very strong prior year comp of 7.9%. Adjusted operating income of $1.1 billion declined 35%, broadly in line with our expectations. Headwinds from fewer COVID-19 vaccinations and PCR tests and increased labor investments were partly offset by retail sales growth and gross margin expansion and savings from the Transformational Cost Management Program. Let me now turn to U.S. Pharmacy. Pharmacy sales declined 4%, held back by a 7.8 percentage point headwind from AllianceRx and by significantly lower contributions from COVID-19 vaccinations and testing. Comparable pharmacy sales were up 4.8% despite lapping a solid 6.8% comp last year. The sales growth was favorably impacted by branded drug inflation. Comp scripts were flat. And excluding immunizations, comp scripts were up 2.1%, a sequential improvement of over 200 basis points. We administered 8.4 million COVID-19 vaccinations in the first quarter, down 46% versus the prior year quarter. Flu vaccinations were up versus prior year due to higher flu incidences. Season to-date, we have administered over 9 million flu shots. As expected, pharmacy-adjusted gross profit and gross margin declined in the quarter due to fewer COVID-19 vaccinations, a mix shift to lower margin at-home COVID-19 tests and ongoing reimbursement pressure net of procurement savings. Reimbursement was broadly in line with our expectations and represented a lower level of pressure compared to the prior year. Turning next to our U.S. Retail business. We saw good retail performance in the quarter with continued growth in both sales and margin. Retail comp sales increased 1.4% despite lapping a very strong 10.6% comp in the prior year quarter. Excluding tobacco, comps were up 2.1%. And on a 2-year stack basis, comp sales growth was 13.8%. We benefited from a 220 basis point tailwind from cough, cold, flu. However, this was largely offset by a 170 basis point headwind from lower sales of at-home COVID-19 test. Comp sales were led by 4.9% growth in Beauty and a 2.9% increase in consumables and general merchandise. Both categories benefited from own brand offerings and decisions to invest early in inventory availability. We delivered another quarter of strong retail gross margin performance, reflecting effective margin management, including strategic pricing and promotional optimization and favorable shrink trends. Turning next to the International segment, and I'll talk to constant currency numbers. Sales increased 4.6%, with growth across all international markets. Boots UK was up 4.3% and Germany wholesale grew 4.2%. Adjusted operating income was $116 million, down 20% versus prior year. Strong UK retail sales and good operational execution in the Germany wholesale business were offset by lower demand for COVID-19 pharmacy services in the UK, the adverse gross margin impact of NHS pharmacy funding and the expiration of temporary rental reductions received in the prior year. On a combined basis, these three items had an impact of around 27 percentage points. Looking forward, we do expect the International segment to return to strong profit growth in the second quarter. Early indications show that boots had a strong Christmas season with comp sales growth of around 15%. Key categories, including gifting, beauty and fragrance performed extremely well along with an uptick in OTC, cold and immunity categories. Let's now look in more detail at Boots UK. Boots UK sales growth of 4% was led by continued strong retail performance. Comparable retail sales advanced 8.7% and this is coming on top of a 16% comp growth in the year ago quarter. Footfall grew 8% with flagship and travel locations again showing robust improvement. Foods continued to gain market share with personal care and health and wellness performing particularly well. Comparable pharmacy sales declined 0.9% reflecting lower demand for COVID-19 services. Boots.com continues its strong performance with sales more than doubling versus the pre-COVID period. Approximately 18% of our UK retail sales came from Boots.com in the quarter, which compares to roughly 9% in the equivalent pre-COVID quarter. November was a very strong month with Black Friday being our biggest ever online event. Turning next to U.S. Healthcare. We are very excited about developments in our U.S. Healthcare segment as the business continues to rapidly scale. Sales were almost $1 billion in the quarter compared to only $50 million in the year ago quarter, pro forma combined sales growth of 38% compared to 34% in the fourth quarter of fiscal '22. VillageMD had sales of $550 million, advancing 49% on a pro forma basis, with growth driven by existing clinic growth and expansion of the clinic footprint. Shields again showed very strong growth with sales of over $100 million and pro forma growth of 44%, driven by recent contract wins, further expansion of existing partnerships and strong executional focus. In its first full quarter, CareCentrix delivered sales of over $330 million. Pro forma sales growth was 22%. Segment adjusted operating income was a loss of $152 million. This was flat sequentially and compares to a loss of only $13 million in the year ago quarter. Adjusted EBITDA was a loss of $124 million in the quarter compared to a loss of $11 million in the prior year. The year-over-year increase in losses largely reflects a full quarter of VillageMD in the current year versus 6 days in the prior year quarter and higher Walgreens Health organic investments. These headwinds more than offset positive profit contributions from Shields and CareCentrix. Let's now look at some of the key metrics for U.S. Healthcare. As Roz mentioned earlier, VillageMD ended the calendar year with 393 clinics, including 200 clinics co-located with Walgreens. This was in line with our target. VillageMD had 440,000 value-based patients at quarter end, up 46% from 300,000 at the end of the prior year quarter. At quarter end, the Walgreens Health organic business had 2.9 million contracted lives, up from 2.3 million at the end of the fourth quarter as existing payers added new lines of business. We exceeded our original goal of 2 million lives. As we scale our access to lives and add new partners, we will continue to build out our Walgreens Health Corners. We ended the quarter with 112 Health Corners ahead of our goal of 100. Health Corners play an important role in engaging patients, addressing care gaps and improving health outcomes. Since the program was launched, Walgreens Health Corners have facilitated more than 300,000 patient interactions. In summary, we performed strongly against our key objectives and we are well positioned for future success in the coming year. The addition of Summit Health will further enhance our portfolio of leading assets across the care continuum, drive meaningful synergy opportunities and accelerate the path to profitability. Turning next to cash flow. We generated almost $0.5 billion of operating cash flow in the first quarter, while free cash flow was negative $117 million. Operating cash flow was negatively impacted by increased inventories, including successful advance pays to secure product availability in the U.S. and UK holiday seasons. The year-over-year decline in free cash flow was due to lower earnings, some phasing of working capital and increased capital expenditures related to growth initiatives, including the VillageMD footprint expansion, the rollout of micro fulfillment centers and digital and omnichannel investments. Turning now to guidance. Overall, we are confirming our full year EPS guidance. The guidance now incorporates EPS accretion from the recently closed Summit Health transaction and this offsets the dilution from our reduced ownership stake in AmerisourceBergen. Our projection for the total number of COVID-19 vaccinations is unchanged. But we do now expect a slightly greater headwind from COVID-19 testing due to a demand shift from drive-thru testing to lower margin at home test. This has had a negative impact of roughly 1 percentage point of EPS. Currency rates are somewhat favorable, and this has reduced the year-on-year currency headwind from 2% to 1%. Excluding these items, we continue to project core business growth of 8% to 10%. In terms of phasing, at the midpoint of our guidance, we see a balanced 50-50 cadence between the first half and second half versus our original expectations. This assumes a shift of COVID-19 vaccinations from the second quarter into the third quarter with an impact of approximately $0.09. Second quarter earnings growth will continue to be adversely impacted by the ongoing headwind from COVID-19, continued investments in U.S. Healthcare and labor and the higher tax rate. In the second half of the year, EPS will grow around 30% with good visibility into the key drivers. Firstly, we expect significant second half momentum in U.S. Retail Pharmacy, including ongoing script recovery as we normalize store operations and implement marketing win-back initiatives; favorable trends in reimbursement net of procurement, lower levels of shrink and continued strong retail performance. Additionally, while COVID-19 will remain a headwind in the second half of the year, it will be a lot lower. And we expect an impact that is less than 50% of what we saw in the first half of the year. Secondly, International has delivered a strong Christmas trading period, and we expect to see strong ongoing performance through the balance of the year. Our international business, particularly in the UK, has emerged in a competitively strengthened position and is well positioned for growth. Finally, the first half of the year is the peak investment period for U.S. Healthcare. And consistent with prior guidance, we expect the segment to achieve positive adjusted EBITDA exiting the year. The overall segment will flip from being a headwind in the first half to a significant mid-teens EPS tailwind. Let me now provide some additional detail around our segment sales and profit assumptions. We are raising our WBA sales guidance by $3 billion to $3.5 billion. The increase is driven by VillageMD's acquisition of Summit Health, refreshed currencies and better-than-expected sales in the first quarter. Adjusted operating income is unchanged at $4.7 billion to $4.9 billion. The acquisition of Summit is offset by a lower contribution from AmerisourceBergen as we reduced our ownership stake. For U.S. Retail Pharmacy, we have raised our sales guidance by $500 million due to a better-than-expected first quarter, which benefited from brand inflation and broad-based retail strength. The AOI range is lowered by $150 million to reflect the sale of the AmerisourceBergen shares in November and December. These actions have reduced our stake from around 26% to 17%. We have raised our guidance for the International segment to reflect a lower headwind from currencies. We now expect sales of $21.2 billion to $21.7 billion up $800 million versus the prior range. We are also raising our AOI forecast to $870 million to $900 million. For the U.S. Healthcare segment, we expect sales of $6.5 billion to $7.3 billion and an adjusted EBITDA range from a loss of $50 million to positive $25 million. Both of these are consistent with the goals we provided when the Summit Health transaction was announced in November. We continue to expect to exit fiscal '23 with positive adjusted EBITDA for the U.S. Healthcare segment. Moving on to our corporate assumptions. The full year tax rate is unchanged at around 16%. Interest expense is expected to be $560 million to $580 million, an increase of $70 million to $80 million compared to prior guidance, and this is mostly due to the Summit transaction. We are raising our forecast for equity method investments and non-controlling interest with the combined range increasing by nearly $100 million versus our prior guidance. This reflects the Summit Health transaction and the acceleration of the full acquisitions of Shields and CareCentrix. In summary, we are raising our fiscal year '23 sales guidance for WBA and we are confirming our full year EPS guidance. Thank you, James. Before we kick off Q&A, let me sum up what you've heard. We are executing against our fiscal 2023 plans with solid first quarter results reported today, broadly in line with our expectations. We performed well against our record levels of growth in the first quarter last year. Our core business is resilient, and we are accelerating our healthcare transformation with a well-defined path to profitability exiting this year. Given our first quarter execution and the Summit Health acquisition, we are raising full year sales guidance, and I'm comfortable reconfirming our adjusted EPS guidance. Our strategy is working. And we will be relentless in driving continued progress ahead. I remain confident in our future growth potential, enabled through our bold investments today and the long-term sustainable value that WBA can create for our customers, our partners, our people and our shareholders. This is Lucas on for Charles. I wanted to talk about script recovery and the investments to return stores to normal hours. I wanted to ask and see how script recovery has gone for the locations that you've returned to normal hours. And how those have trended versus your expectations going into it? And then on the $100 million in investments in Q1, that's close to 40% of the $265 million that you guys guided for fiscal '23. I want to understand if we should expect the rest of that investment to come be front-loaded in the first half? And then how the timing of that investment will impact script recovery as we move throughout the year. Okay. Thanks for that question. I'll start that off and then joining us today is Rick Gates from our pharmacy operations. He will assist in the questions. So we'll add James in there if we need to. So first of all, on our script recovery. It starts with the investment that we've had in our labor position. And let me start by saying that we announced last quarter that we were working to really improve our positions with our pharmacy. So with these investments, our applications are up about 23%, and we've got accepted offers approaching about 40%. So in our minds, the brand remains strong and the intentionality to regain pharmacists in our stores, it's working. Second, I will tell you that stores that are operating without reduced hours had Q1 Rx comp trends including -- excluding immunization in the mid-single digits. And we're seeing about 9 percentage points better growth versus the impacted stores on limited hours. So we feel good about the direction we're moving forward. We continue to make progress on the recruiting. We've got new incentive policies, and we're leveraging the micro fulfillment capacity that we have. And as we improve the store operations for the pharmacists, we're getting better engagement. So we're moving strongly in that direction. We're continuing to see net gains of about 600 incremental pharmacists have joined Walgreens and to the extent that the new pharmacists are being hired, we're seeing these really in some of our more challenged markets. And so as you can imagine, we are focusing on those challenged markets first to regain pharmacy and now we're applying the marketing incentives. And those incentives have been on a one-to-one basis to reengage the consumer back to the store. So we're feeling confident that we're moving in the right direction. So these labor investments have been necessary to move us forward. We like the direction that we see this happening. I will say another thing that's happening in terms of the performance in our stores is also when we look at the balance of the maintenance scripts versus the ongoing scripts. And I will tell you that we are seeing some favorability there. So we feel strongly that this is not a long-term issue for us, but we are regaining the pharmacists back in the stores and reopening the stores accordingly. Yes and just to clarify your question on the timing of the spending of the payroll investment. The $100 million we quoted includes both minimum wage and the pharmacy investment. So it only represents $100 million is about 19% of the -- 20% of the total for the year. And I'll just remind you, the pharmacy investment full year year-on-year was $265 million but there was also a minimum wage investment previously communicated of $260 million. Is that okay? Maybe just to talk a little bit about capital priorities. And if there's any updated thoughts, obviously, with VillageMD, closing Summit? There's discussion about synergies, and you talked a little bit about updated growth objectives there. Can you just comment on how you sort of see the cash flow needs laying out, if there's any updated thinking and priorities? Yes. Just I think from the point of view of funding, we've basically announced anything we intend to do in the short term. So we disposed of ABC, our partial stake in ABC and we raised that to fund the $3.5 billion transaction. We raised about $1 billion. And this puts us in a fairly comfortable place with the rating agencies. Looking at some of it, it's too early to say because, frankly, you can't get involved until the deal closes. So Village and Summit will be moving very, very quickly on the integration and synergies. As Roz pointed out in her material, we have pretty good line of sight to about $150 million of synergies. The cost synergies, we would go after very rapidly. That's about 40% and 60%, which is coming from migration [of] risk, will be over a longer period of time. There were some items not captured in there. For example, we haven't made any assumptions on synergy between Walgreens stores and Summit locations. So there's probably a fair amount of upside to the $150 million. I don't know, A.J., does that answer your question? By the way, we're not considering any M&A type activity in the short term. We're taking a pause. We need to focus on integration activities. So that was the one other thing is you had talked previously about maybe another leg to the Walgreens Health story over time. So that's not a short-term priority. That's a longer-term thing once we get clarity on how all the integration is going with VillageMD and Summit. I think it still is a priority in the short and medium term, but I think the scale of the acquisition won't even trigger on your radar. So we're more likely to buy smaller companies with specific, call it, capabilities that we need to advance our organic business. So we're not going to go out and do a $2 billion or $3 billion acquisition on a health tech company, we're likely to be very targeted, and it will be in the hundreds of millions, not in the billions. Also, James, I know that you guys don't provide quarterly guidance, but could you maybe talk a little bit about expectations for cadence this quarter had a good portion of COVID and COVID pull forward into it. Fiscal Q2 seems like it's going to be a little bit below The Street. And maybe the question to focus on here is kind of what inflects the most as you think about the back half of the year? And if we think about earnings risk, like maybe talk about the biggest points of inflection, which we would see as the biggest points of risk. Yes. That's an unexpected question. I would like to give a little bit of context first on the first quarter because there's a perception out there that it was overly dependent on tax rate. And I do want to give you our position. As we look against our budget internally, we actually came in $0.01 better and only $0.03 was from tax. So, the tax upside we predicted on the full year, the 16% is still intact, and we had already planned for this type of tax rate in the quarter. As I said, $0.03 better. We're about $0.04 weaker on the operating business, and it was all in international. To be honest, it's a bit of a planning blow. They didn't predict carefully enough what the reimbursement timing was going to be like from the NHS. So it became a short-term margin issue. And I do want to reassure the listeners, we see a return to very strong profit growth in the International segment in the second quarter. So compared to market expectation -- to our expectations, we came in relying $0.03 on tax. So the beat of $0.04 was you can say all due to tax, right? But the core business was on track. And the only thing that surprised us was international and it was more about planning than it was execution. And I do want to emphasize, we won the Thanksgiving -- sorry, Black Thursday type events in the UK and then we did put it in the prepared comments. We make 40% of the profit in the UK in December. The growth in December was 15% on the front of store, which is 70%. So now I'll go to your real question, which is the cadence between the first and second half. We looked into the second quarter, and versus the consensus that was out in the market that the consensus felt a little heavy only for one reason. There is a shift going on right now. Vaccinations have slowed down. The boosters have slowed down a bit. So there's a slight shift into the Q3 from Q2, and that cost us about $0.09. That's the only change we're making to our thinking first half versus the budget we had before. There are no other changes. And I just want to be very clear on that. When you look at performance versus consensus models, and we do look at this, and I'll just be very transparent. We collect like, I don't know, 2017 models and we compare whether it's gross profit or SG&A and all the rest. Our actual absolute gross profit in the quarter was better than consensus by $60 million and it was better than FactSet by $94 million. So where we're getting the disconnect is on the SG&A. And my hypothesis there is there are some impacts from currency. There are some impacts from the way you've built in some of the investments in labor. And we have to dig into it that we haven't communicated succinctly enough what the SG&A outlooks are on a quarterly basis. But we're looking at here. We're exiting the quarter feeling like operationally most of the businesses were on track. In fact, the U.S. business came in stronger than the budget. So let's look at first half, second half. We basically said now it's a 50-50 split. And that implies that the first half will be down EPS roughly 28% to 30%, just round numbers. And it's driven by COVID, the labor investments and the healthcare investments. It's -- the story doesn't change in the second quarter, and it's consistent with original guidance. And you've asked for -- and this is a bit of a long-winded response. You've asked for what are the key drivers, first half versus second half. The first one is vaccinations and testing is a headwind in the first half of 20 to 21 percentage points. So if you take the first half of the year, we will be pulled down to the tune of 21%. If you take the second half, that goes below 10%. So the change of the headwind, it gives you an improved profile of about 11 to 12 percentage points. The biggest driver, however, is healthcare. In the first half of the year, that's a negative drag on income in the low single digit. And we said in the prepared comments that the healthcare business will drive EPS around mid-teens, so call it 15%. So the change between the first half and the second half, you got 11 to 12 points coming from COVID and you've got, call it, 15 to 18 points coming from healthcare. The other big numbers are reimbursement, and we haven't provided much guidance on this in the past. We expect, and we have a very good line of sight because I would call it, 95% of all contracts are closed, reimbursement in the second half of the year compared to the first half will be less than 50%. So this gives us a tailwind of approximately $350 million in the second half of the year. So if you take second half versus first half, just due to the timing of reimbursement, I'm probably going to get 14 percentage points of growth, and I have extremely high line of sight to that number. The second one is volume. Volume in the second half will probably be -- the volume contribution in pharmacy will be about 3x what it was in the first half because as we said, the marketing programs will kick in later in the year. That's worth probably another $200 million, so call it 8 points of growth. So we're going to see a big change in the trajectory of the pharmacy business in the first half versus the second half. And the final one I'll leave you with is, we did -- while we hit the absolute gross profit in the quarter, pharmacy margins were lower than we anticipated because we had some timing items on cost of goods sold, they're going to wash out in the remainder of the year. And that's probably another $200 million to $300 million. So what we're really looking at is quarter one being a fairly difficult quarter in terms of -- the majority of the costs are concentrated in the first half of the year and have coming out in the second half. Reimbursement, as I said, $350 million. Good line of sight volumes on pharmacy. Good line of sight at the programs are there. There's always some risk to it. And the cost of goods sold items another $300 million. These are very large numbers. So you're talking about pretty explosive growth in the U.S. business in the second half. And I do want to reiterate, we're going to see the same from the international business. So I don't know if that's enough insight, I've gone on for too long, it's probably too much, but… Maybe to piggyback just off of that last question, thanks for all the details there. Could you specifically comment on some of the other things you called out in terms of shrink the strong retail performance? And then also what your expectations are for cold, cough and flu given some of the product shortages we've been hearing about? Yes. I think the shrink is built in the forecast. We're probably -- maybe we cried too much last year when we were hitting numbers that were 3.5% of sales. We're down in the lower 2s, call it, the mid 2.5%, 2.6% kind of range now. And we're stabilized. So -- but we've spent a fair amount, and that could be one of the disconnects in SG&A. We've put in incremental security in the stores in the first quarter. Actually, probably we put in too much and we might step back a little bit from that. But what we're seeing is we're putting in more law enforcement as opposed to security companies. The security companies are proven to be largely ineffective. So we're investing more SG&A to drive the lower shrink. And it's -- actually, we're quite happy with where we are. It's around 2.5% to 2.6%. So that's well below the prior year levels. And we have a fairly good line of sight to new programs going in. The second part of the question? Cough, cold, flu. Yes, we did get a bounce from cough, cold, flu in the quarter. But as you look at our retail business in the first quarter, where the comps came in at cough, cold, flu boosted the result for the tune of, I think it was 220 basis points. But on the flip side is the COVID OTC tests were a headwind of 170. So actually, the way I'd encourage you to think about the first quarter is, if you take out the noise of the two of these, roughly the business is doing a 2% comp. And if you go back to the guidance we gave three months ago, we actually said we expect the retail business to do a 2% to 3% ex COVID. We did see a little bit of weakness in some of the -- some other categories. But I think where we won in the first quarter was we built fairly aggressive inventory levels, and we were extremely well positioned on cough, cold, flu and we've actually gained share in the category. We will get some opportunity on the full year from cough cold flu. It's too early to say what's going to happen in the second quarter. Honestly, we've seen a little bit of a slowdown in the last few weeks. Flu vaccinations are still up, I think, 9% or 10% versus prior year. So there's no issue in cough, cold, flu. It has given us a bit of a boost. But as I said, if you think about cough, cold, flu in the first quarter, it was offset by these cost items in pharmacy that I talked about, and they'll roll out of the system in the second half. I'm going to take it more from a strategic standpoint. So when I think about your U.S. Healthcare business and Summit, CityMD as well as VillageMD. Can you maybe just spend a minute and talk about how you think about them, integrating and fitting together. As I understand it, both Summit and CityMD today are primarily fee-for-service. I think the reason that VillageMD was at a loss is that they have at-risk lives. So as you think about this over the next few years, is the goal to move more people onto the platform from an at risk perspective. Where do you see those opportunities? Summit is in a single market. Do you think you can replicate some of that multispecialty and other markets? James I know you did some numbers around some of the synergies. But just more conceptually, I want to try to understand how you're viewing this going forward? Yes. And I think we -- I did allude to it. And I think there's two pieces you should think about. One of them is easier and one of them is tougher. The easier one is the capabilities that VillageMD have in value-based care. So right now, they have roughly 440,000 patients, I'll call it on a value-based arrangement out of roughly 1.6 million total patients. So they're in their own evolution. And of that 440,000, 125,000 are fully at risk. So that is delegated -- full delegated risk from the insurance company. So Village’s standalone is they want to grow the 125 and they want to grow the 440 as a percentage of the total 1.6. But bear in mind here, it's really, really, really, really important to have commercial patients. They pay the bills, right? And they allow a very effective procurement and negotiation model in the local markets. Strategically, I think, Lisa, the one difference versus a year ago is there's a decision by Village to get bigger in fewer markets. And what I mean by that is scale locally is critically important. And that's why Summit and CityMD was a very attractive acquisition. So the game that they have to play in Village is, they'll probably run the businesses somewhat independently for a period of time and transfer of value-based care management into City -- sorry, into Summit Health and Summit Health will grow its patient population that is at risk. So that's the opportunity. That's the $19 million. The other one is a little bit more complex, which is -- the beauty of the Summit model is they have a multi-specialty business and they have a primary care physician business. And they are feeding, if you like, patients between each other and cross referring between the two. So when and if they take on risk, they will manage a much greater proportion of the total cost of care because you know how much specialty or multispecialty care cost. So instead of village, which firms out its business to local providers, Summit will be able to use its own providers to directly manage the cost of care. And I would argue, have a much higher return on the risk-based patients. The question is how do you push the multispecialty into the Village practices? I know the Village team are looking at bigger primary care physician practices that incorporate more multi-specialty type activities and testing. So -- but I would take the second -- the first one, the move to value-based care will happen in the first contract year. So I would call it in the current contract year. In the case of the multispecialty, I think that's a 5-year journey and that does require investment because you'll have to change the structure of your local practices. But I think it's quite exciting because none of the multispecialty opportunity and none of the synergy between Walgreens and Summit is built in the projections that we provided to The Street back in November. So we see a fair amount of opportunity. I know you know there's a lot of debate on The Street of the company's ability to gain back that 30 million of scripts that is embedded in guidance. And I know some of that 30 million scripts is just regaining market share, of stores closed, hiring pharmacies. But I know Summit also is just regaining like people that haven't left Walgreens that maybe have been compliant to therapy and pharmacists during COVID due to the basic blocking and tackling. And to me, that feels like an easier get than bringing someone back to Walgreens. So could you let us know how much of that 30 million maybe break it down, what is actually having people come back to a Walgreens versus what is versus people being more compliant to therapy? And secondly, your free cash flow was negative. Can you give us any type of free cash flow guidance for the year? That would be great. James, why don't we start with the free cash flow? And then, Rick, just go into the detail around the script performance on the core script business. Yes, we're not going to give guidance on the full year. Honestly, we're still working through some of the implications of the Summit acquisition. But I think you'll see some progress year-on-year on an absolute basis. The first quarter is traditionally quite weak as a start in the company. So I wouldn't get very concerned by it. We are looking carefully at the investments in the rest of the business and to optimize cash flow for the rest of the year. But we're not going to start giving guidance on that. And just to -- this is Rick. Just to walk into the 5% script growth, there's actually building blocks that are part of that. And I think you are correct. Part of it is just market growth that we have that is the first part of the building block then it goes into the adherence and services, which are a key part of all the programs we've invested in. So that is a huge part of how we're going to continue to grow scripts -- the marketing win-back plans based off of staffing is the third one, then obviously, core staffing and reopening of store hours is the fourth building block. And I would say that as you look at the cadence of scripts and how it's going to grow into the second half of the year, Roz has talked a lot about the hiring pieces, but it actually goes into -- there's kind of a time line to get there, right? You have to hire. We have to train appropriately, get our pharmacists ready, then we will reopen our stores to full store hours that we have before and then obviously, the win-back program. So there is a timing element to the scripts and how the growth will really start to ramp up in the second half of the year. I guess one just quick clean-up question and one broader one. First, on the clean-up side, is it possible if you could give us the after-tax proceeds from sale-leaseback transactions for the quarter? That would be great. And then maybe on the international side, I understand the success that you've had on the various different holiday items for the UK. But can you give us a sense whether it's FX oriented beyond that, how to think about the confidence level you have in raising the adjusted OI for segment for the year and all the moving pieces beyond simply the contribution that you got from the Black Friday, Black Thursday, I apologize if I missed a couple of the holidays there, James. Yes. So the -- I'm just looking for the sale and leaseback. I think it was around 170 pre-tax. I don't have an after-tax number. But we don't -- on a cash tax basis, we don't pay very much tax on this because we have capital allowances -- capital losses against it. In the UK, what we did was a technical update basically to reflect only currencies. So if currencies change in the future, we would adjust that. We have -- I would describe it as a large degree of confidence in the base forecast in the international business. I would suggest that given how December came in, which was better than we expected, that 15% growth. And as I said, 40% of the profit is in December. So this takes -- massively derisks the international forecast. So I don't -- you never want to say anything is in the bag, but I think international is probably the very safe number. And just to cycle back a little bit on -- everybody, I think, has been very, very focused on the 5% script growth rate. 2.5 percentage points comes from the marketing programs on the store reopening and 2.5 comes from market growth plus adherence programs, plus all the rest. So there is the possibility that we overperform on some of the other programs that will compensate for some of the risks that you perceive. And then two is just to dimensionalize this and -- sorry, the labor on, but the change in the direction of procurement is $350 million and the change -- second half versus first half and the volume change is 200. So if you were looking in terms of what's going to have the biggest impact second half versus first half, it's reimbursement, cost of goods sold changes versus first quarter and then it's volume on the pharmacy business. And I'm not saying it's not important, but we have a very, very good line of sight to the reimbursement and we have decent line of sight to the cost of goods sold, and we have programs in place for the script volumes. So I just wanted to kind of close on that, kind of stealing your last question. And this ends our Q&A session. I will now turn the call back over to Ms. Roz Brewer for some final closing remarks. First of all, thank you, everyone, for joining us this quarter. We'll conclude our Q&A but I want to end briefly by just recapping the main points that you heard from us today and then touch again on some of your questions. First of all, we have had a solid start to the year. Our results are broadly in line with expectations and our underlying sales growth is over 3% despite the tough environment we've all been in. Secondly, our core business is resilient, the convenience and value that we're offering customers continue to resonate as we cycle from the COVID surge. And it reminds us every day that our brand remains strong and our customers are very loyal to us. Thirdly, our healthcare growth engine is showing great progress. We've closed and accelerated major acquisitions, and this segment is expected to exit fiscal '23 with positive adjusted EBITDA so we're investing to grow in a very difficult time frame, but we remain committed to our strategy. Fourthly, we're optimizing our portfolio. So our shares in AmerisourceBergen were sold with tight discounts and near 52-week highs, and we continue to have significant access to capital. And lastly, we're maintaining guidance for the fiscal year, while controlling cost, and investing to grow to deliver our long-term sustainable value for all of you on this call. So thanks again for your support, and we wish you all a very Happy New Year. Thank you.
EarningCall_1442
Hello, everyone, and welcome to the Johnson Outdoors Fourth Quarter 2022 Earnings Conference Call. Today's call will be led by Helen Johnson-Leipold, Johnson Outdoors' Chairman and Chief Executive Officer. Also, on the call is David Johnson, Vice President and Chief Financial Officer. Prior to the question-and-answer session, all participants will placed -- will be placed in a listen-only mode. After the prepared remarks, the question-and-answer session will begin. [Operator Instructions] This call is being recorded. Your participation implies consent to our recording this call. If you do not disagree with these terms, simply drop off the line. Thank you. Good morning, everyone. Thank you for joining us for our discussion of Johnson Outdoors results for the 2022 fiscal fourth quarter. If you need a copy of today's news release, it is available on our Web site at johnsonoutdoors.com under Investor Relations. I also need to remind you that this conference call may contain forward-looking statements. These statements are made on the basis of our current views and assumptions and are not guarantees of future performance. Actual events may differ materially from those statements due to a number of factors, many beyond Johnson Outdoors' control. These risks and uncertainties include those listed in our press release and filings with the Securities and Exchange Commission. If you have additional questions following the call, please contact Dave Johnson or myself. Thanks, Pat. Good morning. I'll begin with an overview on the fiscal year results, and then I'll share perspective on the performance and outlook for our business. Dave will review financial highlights, and then we'll take your questions. In fiscal 2022, total company sales declined 1% and to $743.4 million compared to the prior record setting fiscal year. Net income for the year was $44.5 million or $4.37 per diluted share, a 47% decline from the prior fiscal year. Operating profit decreased 40% to $66.3 million versus $111.3 million in prior fiscal year with the challenging supply chain situation, primarily in our Fishing business, significantly impacting our profitability. Managing the challenging supply chain environment remains a key priority, and we will continue to evaluate all avenues to mitigate cost pressures into the next fiscal year. In Fishing, while supply chain challenges persisted throughout the first part of the fiscal year, we saw supply availability start to improve during the fiscal fourth quarter. Sustaining innovation leadership in fishing is also our focus, and we are always looking for new ways that Humminbird and Minn Kota products can connect and work together to deliver new benefits to anglers. Our recent innovation in Humminbird, the award-winning MEGA Live Imaging TargetLock used in conjunction with our Minn Kota Ultrex trolling motor makes it easier for anglers to stay on point and catch more fish. During fiscal 2022, MEGA Live Imaging TargetLock received the best in category for electronics honors at this year's ICAST, marking our 11th award in this category in the past 12 years. Moving on to our Watercraft Recreation business, the success of our Old Town Sportsman line gave us momentum in a moderating market. Part of this innovative line of boats is the award-winning wildly versatile lightweight sportsman Discovery Solo 119, a solo canoe that paddles like a kayak and is great for fishing, waterfowl hunting and enjoying lakes and rivers. The Sportsman line offers a Watercraft for everyone looking to enjoy a great day on the water. Our camping business saw double-digit growth even as the market started to moderate compared to the unprecedented high demand of last fiscal year. Participation in the activity remains high and demand for our unique consumer tents and stoves is strong. And in Jetboil, consumers remain excited about the innovative superlight Stash Stove that continues to grow since launch. Finally, our diving business continues on a growth trajectory as dive markets continue to experience recovery as several regions around the world reopened and tourism resumed. Sustaining innovation is critical to our growth, and divers are loving the award-winning powerful Seawing Supernova Fin that SCUBAPRO recently launched. The Supernova is the go-to fin for avid recreational and professional divers seeking maximum speed, power and kicking control in all diving conditions. Our continued innovation efforts will ensure SCUBAPRO's position as the most trusted dive brand in the world. In summary, it's good news that we are seeing some relief with supply chain issues, and we continue to look at all options to mitigate challenges in our overall profitability. Orders for our products remain strong, and we continue to work hard to replenish inventory levels with our loyal customers. While it's unclear the extent to which economic conditions and inflation may affect consumer buying behavior in the future, as always, our team takes the long-term view, working hard to position our brands and businesses for growth well beyond the next quarter or next year. Thank you, Helen. Good morning, everyone. I want to highlight a few items from the fourth quarter and the year. As Helen mentioned, supply availability starts to improve in the fiscal fourth quarter. As a result, total company fourth quarter sales were up 18% compared to the prior year's fourth quarter. While Fishing and Diving saw strong revenue growth in the fourth quarter, Camping and Watercraft Recreation declined versus the previous fourth quarter. For fiscal '22, gross margin of 36.5% is down 8 points from last fiscal year due to significant increases in material costs. We saw some relative improvement in our costs in the fourth quarter, but we expect margins to continue to be impacted by inflationary pricing conditions. Operating expenses for fiscal '22 decreased $17.8 million versus the prior year. The decrease was primarily due to lower variable and deferred compensation expense incurred in fiscal '22. Warranty and bad debt expense were also down versus last year. Profit before income taxes was $58.9 million versus $112.9 million from the prior year. Net income for fiscal year was $44.5 million, down 47% from the prior fiscal year. The effective tax rate was 24.4% compared to last year's rate of 26.2%. As a reminder, we built significantly higher inventory levels for several quarters to help mitigate supply chain disruptions and meet increased demand for our products. Heading into fiscal '23, we remain focused on monitoring demand and proactively managing higher-than-normal inventory. We continue to have no debt on the balance sheet and our cash position enables us to invest in opportunities to strengthen the business. We remain confident in our ability to deliver long-term value and consistently pay out cash dividends to our shareholders. Good morning and thank you for taking the questions and certainly had a very nice finish to your fiscal year. So first, I just wanted to get a better sense as far as the commentary about the strong orders. Is that primarily fishing? And also, if you could just touch on the backlog of unfulfilled orders, if you could just give us some color on that, that would be great. We've got continuing backorders we're continuing to work those down in fishing and we are - as we get into building inventory for the next season and we get some preorders in, so they're all getting kind of mixed together, but we have solid orders in fishing and getting back to the normal kind of order placements that we have seen historically in the other businesses. So we feel good about the position. We haven't seen cancellations. So it's a positive sign. Got it. Okay. Thanks for that. And can you give us a sense as to what you're hearing from your retail partners as far as current demand levels? And what’s your sense as far as the inventory levels at retail? Well, we are still building inventory at retail. Our supply situation eased up a little bit this past quarter. So that's given us an opportunity to ship to customers and have them start building. We are still not to the levels that we want to be, but I think demand - the holiday season has been better than I think we expected, but jury is out on what happens going forward, but obviously, we had a very strong fourth quarter. So that was a very good sign. Okay, got you. And then historically, the company's gross margin have been in the mid 40% range. Do you expect -- over time, of course, do you expect to get back to those types of gross margins? Or do you think there's been a structural change to the business where those types of margins are not achievable? Well, those were very different times. Obviously, we will keep that as a goal to get back there. I think right now, we're dealing with significant cost increases on raw materials, and we're assuming those will come down. We don't know how much they will come down. But we do -- we are going to work hard on getting our margins back up, whether it goes all the way up is yet to be seen. Okay, got you. Okay. And then -- so as far as the comment also about the focusing on and evaluating options to address increased costs and the efficiency of your supply chain. So can you share with us more details as to what you're doing there to bring also inventories back in line to more normal levels. I mean, yes, the cost structure and the margin question, I mean, we're looking at everything to improve that. So we've taken price increases in the past. We'll continue to look at our pricing structure and look to see what makes sense versus our demand and our margin profile. We're also trying to find ways to decrease our cost coming in. And part of that is going to be marketplace driven, but part of it is looking at sourcing, design, how we design products, et cetera. So we're looking at everything there. And then on the inventory question, yes, our inventory is higher than where we'd like it to be. So we're really working hard on managing that and making sure that we can keep that more balanced. It will probably be end of the season we get that done. Okay, got you. Okay. And then your balance sheet still remains a strong sort of even though, to your point, you have higher than normal inventories. Can you just talk about your cash flow priorities? And also CapEx, it looks like it was higher than normal this year, and any sort of ballpark estimate, Dave, as to where you think fiscal '23 CapEx will be? Yes. I mean the CapEx spending will -- we expect that to go down in fiscal '23, maybe 15%, 20% versus where we had in '22. We had some facility work that we did in '22 that is not going to be repeatable, not repeated in '23. So I would expect a 15%, 20% decline in CapEx. Okay. Okay. And then otherwise, your cash flow priorities, I know you talked about the dividend. Are you guys still looking at potential acquisitions or maybe looking at buying shares? Well, we're always looking for good acquisitions. And they have to fit, they have to be strategic, and it's always on a radar screen. So from that perspective, again, always, always looking. Dave, can you talk about the …? Yes. I mean beyond that, we like to see a good healthy dividend and I think we've achieved that. So we'll continue to look at our regular dividend and make sure that's meaningful for the -- for shareholders, and as we've talked before, I mean, we look at all other options on how to utilize the cash beyond growth for the company. And that's an ongoing discussion about other options that we utilize the cash. [Operator Instructions] And I'm currently showing no further questions at this time. I'd like to hand the conference back over to Ms. Helen Johnson-Leipold for closing remarks. Thank you. This concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day.
EarningCall_1443
Good afternoon and welcome to Nucor's Fourth Quarter Earnings Call. All lines have been placed on mute to prevent any background noise and today's call is being recorded. After the speaker's prepared remarks, I will provide instructions for those wanting to ask questions during the Q&A session. Thank you, and good afternoon, everyone. Welcome to Nucor's Fourth Quarter and Year-end 2022 Earnings Review and Business Update. Leading our call today is Leon Topalian, Chair, President and CEO; along with Steve Laxton, Executive Vice President and CFO. We also have other members of Nucor's executive team with us who may provide comments during the Q&A portion of the call. They include Dave Sumoski, Chief Operating Officer; Al Behr, responsible for Plate and Structural products; Noah Hanners, responsible for Raw Materials; John Hollatz, Bar products and Fabrication; Doug Jellison, Corporate Strategy; Greg Murphy, Business Services, Sustainability and General Counsel; Dan Needham, Commercial Strategy; Rex Query, Sheet and Tubular products; and Chad Utermark, New Products and Innovation. This morning, we posted our earnings release and an updated slide deck to the Nucor Investor Relations website. We encourage you to access these materials as we will cover portions of them during the call. Today's discussion will include the use of non-GAAP financial measures and forward-looking information within the meaning of securities laws. Actual results may be different than forward-looking statements and involve risks and uncertainties outlined in our Safe Harbor statement and disclosed in Nucor's SEC filings. The appendix of today's presentation includes supplemental information and disclosures, along with a reconciliation of non-GAAP financial measures. So with that, let's turn the call over to Leon. Thanks, Jack, and welcome, everyone. I would like to begin by highlighting some recent organizational changes. Earlier this month, Noah Hanners joined the executive team as EVP for Raw Materials. Noah is a West Point graduate with his Bachelors of Science in Mechanical Engineering and his MBA from UNC Chapel Hill. He also served our nation in the United States Army for nine-years. Noah began his career with Nucor in 2011 at Nucor Steel Darlington and has worked at several of our divisions, most recently serving as Vice President and General Manager of the David Joseph Company. Doug Jellison, previously EVP of Raw Materials has accepted the newly created role of EVP for Strategy. Doug has been with Nucor for more than 30-years and has a great understanding of all of our business segments. As we continue to grow Nucor, Doug will continue to help ensure we are further leveraging our competitive advantages across the enterprise. Congratulations to both Noah and Doug. Now turning to our year-end review. I'm proud to announce that 2022 was the safest and most profitable year in Nucor's history, breaking prior record set in 2021. In the face of uncertain and at times volatile market conditions, we stayed focused on our goal of becoming the world's safest steel company and our mission to grow the core, expand beyond and live our culture. In terms of safety, we established another record low injury and illness rate for the fourth consecutive year. 20 Nucor divisions went the entire year without a single recordable injury, and we set new records across each of the four primary safety metrics that Nucor tracks. And we achieved all of this during a period of rapid growth welcoming over 2,000 new team members to the Nucor family throughout the year. I'm inspired by the way, each member of the Nucor team has embraced our most important value, the health, safety and well-being of all 31,000 team members who make up our family. Turning to financial performance. We earned $4.89 per share in the fourth quarter of 2022 on her way to setting a new earnings record of $28.79 per share for the full-year. This represents a 24% increase over the annual EPS record we previously set in 2021. Our operations continue to generate strong cash flow with a record 11.6 billion of EBITDA. This allowed us to advance our strategy along several fronts, while also returning 3.3 billion to shareholders through dividends and share repurchases, consistent with our capital allocation strategy of returning at least 40% of earnings to Nucor shareholders. Our return on invested capital stands at a healthy 35%, and we closed out the year by announcing the 50th consecutive annual increase to our regular dividend following Nucor's original listing on the New York Stock Exchange in 1972. This places Nucor among an elite group of roughly 40 dividend kings referring to publicly traded companies that have consistently increased annual dividends to shareholders for over a half a century. These successes were in large part made possible through their hard work and dedication of the Nucor team who executed our strategy to achieve world-class performance. As most of you know, we share our profits with our team and in just a few weeks, we will reach a milestone never achieved before Nucor's history, delivering nearly $1 billion back to our teammates. In 2022, we made considerable progress along all of our strategic initiatives, deploying approximately $2 billion in CapEx and completing five acquisitions valued at approximately $3.6 billion, to grow our core and expand beyond. But we didn't just invest in new assets and business lines. We invested in a more sustainable future. We did this through new partnerships and capital commitments to our technologies that can help reduce our carbon footprint even further. In December, we announced an equity investment in Electra, a boulder-based start-up that has developed a process to produce carbon-free iron used in making steel. In November, Nucor became the first major industrial company in the world to join the United Nations' 24/7 carbon-free energy Global Compact which aims to accelerate the world's transition to clean, affordable and reliable electricity. Nucor also cofounded the Global Steel Climate Council in International Coalition advocating for a single, transparent global emission standard that is focused on steelmaking emissions and last week, the NRC officially certified new scales design to build a small modular reactor, the first of its kind approved for use in the United States. Nucor's minority investment in NuScale will continue to support the development of this technology with the goal of producing 100% of carbon-free electricity. Our mission to grow the core, expand beyond and live our culture is delivering results for our company and our shareholders. In our steelmaking operations, we invested in new capabilities to produce more value-added products and improve operating efficiencies that can earn higher and more sustained margins. In our downstream operations, we continue to expand into new steel adjacent markets where we can offer differentiated solutions, including overhead doors and utility towers. These represent unique opportunities in faster-growing markets where Nucor can leverage its core competencies, supply chain efficiencies and market channels to create incremental value for shareholders. And we lived our culture. For over 50-years, Nucor's unique culture has created value for shareholders as it empowers and incentivize teammates to take ownership of decision-making, drive efficiency and pursue innovation. Let me provide an update on some of our larger initiatives to grow the core, starting with our Brandenburg Plate Mill. Nearly four-years after it was first announced, the Brandenburg team rolled their first steel plate on December 30. They are now focused on final commissioning of the mill and plan to begin customer shipments by the end of the quarter. Last week, we announced the Brandenburg mill would produce a new product called Elcyon, a sustainable heavy-gauge steel plate designed to meet the growing demands of the offshore wind industry. Congrats to the entire Nucor Brandenburg team for delivering one of the safest mill start-ups in Nucor's history and for completing it on time and on budget. Turning to our sheet operations. We announced plans to build a continuous galv line at California Steel Industries to serve construction markets in the Western United States. Recent closures of galvanizing capacity by other suppliers in the West presented Nucor a unique opportunity to better serve this region. This new galv line along with the line we completed at Nucor Gallatin in 2019 and future lines planned for Berkeley and Nucor West Virginia will position the company as a supplier of choice for the cleaner, value-added sheet products our customers are seeking in several key markets. Investments like this help forge even stronger relationships with our key customers, like Trane Technologies, which honored Nucor last week with their 2022 Supplier of the Year award. Now shifting to our Expand Beyond strategy. I would like to provide an update on a few of our recent acquisitions we have completed, beginning with our midyear purchase of C.H.I. overhead doors. When we announced this transaction and held a special investor call last May, we spoke about C.H.I.'s $230 million LTM EBITDA, it is 30% EBITDA margins and average annual revenue growth of 10%. In the last six-months following our June closing, C.H.I. generated record EBITDA of nearly 170 million, finishing the full-year with over 320 million of EBITDA and expanding margins. Within the first six-months of closing, we have taken our implied trailing EBITDA acquisition multiple down from 13 times to just over nine times. Going beyond the strong financial results, I want to commend the entire C.H.I. team for executing such a quick and seamless integration into Nucor. We are already seeing the benefits of our combined operations, including improvements to C.H.I.'s safety performance. Thank you. Thank you, team C.H.I. and all of the Nucor team members had have come together to make this an incredibly successful transition. And we are starting to realize supply chain synergies as well with C.H.I., developing plans to source most of its cheap bar and tube from Nucor divisions. The sales team at C.H.I. is collaborating with Nucor's regional commercial groups and cross-selling efforts have begun as C.H.I. grows its share of the commercial overhead door market. Last year, we also acquired Summit Utility Structures, producer of steel structures for the utility, telecommunications and transportation sectors. It is an area that we see considerable growth potential in. Then in December, we announced plans to construct two new state-of-the-art tower production plants. These highly automated facilities will help meet the growing need for utility infrastructure as our nation's electric transmission grid is modernized and hardened. Turning to the broader economic backdrop. We recognize there continues to be uncertainty, but we also see tailwinds that should benefit Nucor as well as the American steel industry throughout this decade, including the Infrastructures Act, the CHIPS Act and IRA that are all starting to work their way into the steel sector. These programs align perfectly with Nucor's unmatched and unrivaled product capabilities to meet the growing demand of our customers today and well into the future. Thank you, Leon. As Leon mentioned, our earnings of $28.79 per share established a new record for the company. These results highlight the earnings power of Nucor's diversified portfolio and industry-leading capabilities. 2022 was also a noteworthy year for cash flows at Nucor. For the year, cash from operations exceeded $10 billion for the first time in our history, and free cash flow topped $8 billion. Over the past five-years, Nucor has generated $16.6 billion in free cash flow. During that same time period, we returned $9.7 billion directly to shareholders through dividends and share repurchases and while at the same time, investing over $12.8 billion in our business through capital expenditures and acquisitions to further strengthen and grow our earnings base. These results demonstrate continued and consistent adherence to our balanced capital allocation framework. Nucor's efficient manufacturing business model is a powerful through-cycle cash flow generator. Turning to our financial results for the fourth quarter. Earnings for the Steel Mills segment were down nearly 60% from the prior quarter. Shipment volumes fell 13%, reflecting normal seasonal weaknesses and some purchasing hesitancy as prices were trending lower for much of the quarter. Overall, metal margins contracted as lower realized pricing outpaced lower cost for metallics. Conversion costs were slightly lower compared to the third quarter despite lower utilization rates, in part due to energy cost, which fell approximately 10% on a per ton basis. Alloys and consumable costs also trended slightly lower. Shifting to our Steel Products segment. We continue to see very strong performance with segment earnings of $1.1 billion in the fourth quarter. This is down about 10% from the third quarter's record results, but still represents the third best earnings quarter ever for this segment. Contributions from most product lines were down from their respective third quarter levels, reflecting normal seasonality. And C.H.I. overhead doors was a notable exception, as Leon touched on earlier, posting fourth quarter earnings 20% higher than the prior quarter. Turning to Raw Materials. This segment saw negative earnings for the quarter as DRI and scrap processing results were impacted by lower volumes and falling prices for much of the quarter. We also took both DRI facilities off-line for planned maintenance and elected to extend those outages for additional service until we saw signs of improving conditions later in the quarter. On the capital deployment front, Nucor's CapEx for the quarter totaled approximately $520 million, bringing total CapEx for the year just under $2 billion. We are forecasting CapEx in 2023 at $3 billion, including some catch-up spending originally slated for 2022, new growth initiatives and general maintenance. The earnings presentation we posted on our Investor Relations site this morning has additional details on our 2023 capital spending plan, including projected allocations among primary CapEx categories, and a preliminary look at the anticipated pace of spending on a few of our major growth projects over the next couple of years. I would like to take a minute and provide an update on the strong results we are already seeing from recently completed investments. While strong conditions in 2022, certainly aided performance, we believe these were prudent, timely and well executed investments that are yielding excellent returns and position the company for continued future success. The roughly $2.2 billion we invested in sheet and bar projects that have been up and running for the past few years, generated an estimated $620 million in EBITDA for 2022. In the businesses we acquired over the last two-years for around $4.5 billion, establishing four new downstream platforms generated EBITDA of nearly $500 million over the course of the year. We believe this puts us well on our way to reaching our annual run rate EBITDA goal of $700 million for our Expand Beyond businesses. Collectively, these strategic investments in those to come, provide significant earnings catalysts and position Nucor for sustained value creation long-term. Turning to our balance sheet. We finished the year in a very strong liquidity position with over $4.9 billion in cash and short-term investments, and our $1.7 billion revolving credit facility remains undrawn. We have been intentional about building liquidity toward the end of the year in light of uncertain economic conditions, coupled with near-term uses of cash, including our 2022 profit-sharing payouts that are earned by our teammates, our capital spending plans and maintaining our commitment to meaningful direct returns to shareholders. In addition to ample near-term liquidity, Nucor's balance sheet continues to be in a position of strength with total debt to capital of around 25% at the end of the year and debt to EBITDA well under one turn. Earlier this week, Fitch Ratings published its first credit rating on Nucor with long-term and short-term unsecured ratings of A- and F1, respectively. We were pleased to see Fitch recognize Nucor's credit strength. During the quarter, we repurchased 3.1 million shares valued at $403 million and made dividend payments of $130 million for a total of $533 million return directly to shareholders, which represents more than 42% of our quarterly net earnings. Over the last five-years, we have returned $9.7 billion to shareholders, representing approximately 52% of total net earnings for the period. As we look ahead to the first quarter of 2023, we expect earnings from our Steel Mills segment to increase compared to fourth quarter results on higher shipments, improved metal margins and expected higher realized prices. In our Steel Products segment, we expect lower earnings in the first quarter compared to the fourth quarter due to seasonally lower volumes and lower pricing in some products. However, it is worth noting that earnings are expected to remain higher than the first quarter of 2022. Our Raw Materials segment earnings are expected to improve on more stable pricing and higher shipment volumes. While operating income from these three segments is expected to be higher compared to the fourth quarter, we expect consolidated earnings for the first quarter to be lower due to higher intercompany eliminations and the absence of onetime state tax benefits that were realized in the fourth quarter. We remain relatively optimistic 2023 will be another strong year of earnings for Nucor despite entering a period of increased economic uncertainty. Overall, non-residential construction spending continues to be robust, federal support for infrastructure and energy projects will begin to show impacts on demand in 2023. Other positive drivers of demand include re-shoring of manufacturing, energy infrastructure demand, clean energy and storage projects, EV factories and semiconductor plants. In closing, we believe medium and long-term fundamentals of our industry and key demand drivers remain relatively positive. This coupled with our growth initiatives and investments that advance our strategy to grow our core and expand beyond position Nucor for strength well into the future. Good afternoon, Leon, Steve, the presentation. Also congratulations to Noah and Doug on the new roles. And also, I would just say nice work to whoever help create those slides, the deck looks great. So wanted to follow-up, Steve, on your last comments on market demand, could you maybe provide a sense to the extent to which demand might be driven also by restocking versus some of these actual real demand drivers that you are highlighting? And then in terms of these real demand drivers, you highlighted nonres, electricity grid, which is moving the needle most for Nucor? Thank you. Lawson, I will start this off and ask Dan Needham, our EVP of commercial to jump in and paint some perspective around what we are seeing in terms of the traction we are getting from some of the programs that we discussed. But I want to begin with saying, hey, thank you for recognizing that. And thank you to the 31,000 team members who made a historic year for our company. Thank you to our customers who made all of that possible. I couldn't be more proud that our team executed its fourth consecutive safest year in our history, it is the most important value that we have at Nucor. And none of us and our executive team take that for granted and I look forward to 2023, setting a new safest year in our history. So as we unpack the first question that you began with or started in really understanding the demand trends real versus the restocking. Look, I think we have certainly hit the bottom as we think about distribution, and we are going to see that continue to restock as we move into the Q1 but that to me is not what is driving demand. If you actually look over the, let's say, the last eight or 10 weeks in the sheet group, for example, our bookings are up 45% to 50% during that time period. Our backlogs over the last - I don't know, let's say, Q-over-Q have climbed about 16%. So that drive is there. That demand is there, that is pulling that. The other side is the nonres construction. Obviously, Nucor is channel in that market is over 50%. So we are heavily invested in that. But there were so many incredibly positive signs. And while 2022 as a historic year, and we are slightly off in terms of order activity, we think it is going to be another very strong year that nonres construction will remain robust as we move forward. And there are several things that are going to drive that, that we will touch on here in just a second. And then really, the other piece is our plate strategy and long product strategy that continues to produce and perform incredibly well as we move through the back half of 2022 into 2023. But as we talk about the Infrastructure Act, the CHIPS Act, Inflation Reduction Act, automotive improvement for 2023, all others are going to have meaningful, intangible impacts to our business. Dan is going to touch on a second, the infrastructure bill. But I just want to put some context to the CHIPS act. It is a $55 billion package that Congress passed. What does that translate to? To about 27 different meaningful chip plants that are going to be produced some of which are pushing $20 billion on their own individual plants. Well, what does that actually translate - what is that look like? That market segment, as we think about advanced manufacturing is requiring something different for its future. Our customers in that sector are requiring the most sustainable, comprehensive, differentiated value products and solutions that are available to the market. Nucor is incredibly well positioned to meet that growing demand in every category in every sector. So we feel very good as we enter 2023, that will be a strong year, maybe not as strong as 2022, but a continued strong year. But Dan, why don't you paint a little context around the Infrastructure Act and what we think we will see in 2023. Okay. Appreciate the question, Lawson. In particular, what we are seeing forecasts out there from construction indices or are predicting infrastructure starts to increase 16% in 2023 and additionally, 10% in 2024. But more specific to that, we are seeing activity today on the infrastructure bill. In January, the Biden Administration announced $2.1 billion in funding for four major bridge projects. The most notable being the bridge over the Ohio River connecting Ohio and Kentucky on I-75 and I-71. You also asked a little bit, and Leon touched on the advanced manufacturing, but the other thing around the advanced manufacturing, the activity is increasing tremendously in that space, not only in chips, but also on the EV space and batteries. But those plants are quite large and the requirements from a grade and size standpoint, there is only a few suppliers that are capable of serving that and Nucor is well positioned to do that. If you think about the breadth of our products, our capabilities in the construction side from structural buildings to racking systems to now insulated metal panels and garage doors. Our capabilities are unparalleled. One thing you also mentioned was the inflation Reduction Act around energy. We are seeing activity grow in that space as well. And additionally, our breadth of capabilities fit that space very well additionally. And if you think about our leading low greenhouse gas intensity offerings, the requirements in that space, we are well poised to help the U.S. energy market move towards decarbonization. So the last point I would like to make is, in all of these, they are not mutually exclusive. They are all interconnected. And we have customers in these spaces in automotive and energy that have requirements on the construction side. And a couple of years ago, we created our focus on our solutions teams. And we have teams around construction, automotive and energy that are best poised to recognize these opportunities early in the design conceptual phase of these projects and work with the owners, developers, engineers to provide a valued solution for all involved, including Nucor. Thank you, Dan. Thank you, Leon. Fantastic color. Maybe just one follow-up for me. If you could comment perhaps on the ramp-ups at Gallatin Brandenburg through 2023, including your thoughts on profitability. Yes, absolutely. As we touched on in my opening comments on Brandenburg, we are incredibly proud of the team. The work that they have done, what they have been able to accomplish. And again, I have been at Nucor, a long time now in 26-years and from a construction standpoint, from a safety standpoint, from a budget standpoint, this project exemplifies the very best of what our team has done and produced. Al Behr will share a few more highlights of that because we have got some recent milestones that the team has reached here in just a moment. And turning to Gallatin, again, we are about six-months behind where we wanted to be on their ramp-up. However, over the last few months, that team has done a phenomenal job of bringing that new cash and equipment online. As I mentioned during the last call, this really wasn't just a brownfield. It was a complete mill modernization with software and automation tying that entire complex together. So it was a significant undertaking. And all that being said, the bottom line in Gallatin, in Q2, we expect them to be at full run rate capability. We will see how the market needs and demands go and meet that demand. But the other piece and point that I would share is we expect Gallatin to be profitable in the second quarter as well. So Al, maybe you want to touch on a few other things at Brandenburg. Yes, I would be happy to, Leon. Thanks, Lawson. We love talking about Brandenburg. Obviously, we are really excited about it. We are sitting here today exactly where we wanted to be. And like Leon said, I just congratulate not only the Brandenburg teammates that have just crushed it in building this project and bringing it in on time and on budget but also our Greater Plate Group teammates at Hertford at Longview at Tuscaloosa that have created an environment in which this mill is going to be excited. And as Leon alluded to, just yesterday, I'm happy to report that we made our first customer shipment out of Brandenburg. So we are on the board, and we are ready to go. In terms of the ramp-up and how we are thinking about 2023, I will share with you that we have got really three focus areas, Lawson, that we are going to think about. Number one is the teammates that we just talked about that they are the difference makers. They are a competitive advantage. You have seen what they have done on this job site and in the market and what they have created. We are going to continue to focus on them. but also that those are the men and women that take care of our customers, which is the second area of focus. So with our customers, we have got existing customers that have helped us get to this point with our plate business. But also new customers in new markets that are new areas for us to go and serve that we couldn't touch before. That if you remember back in 2019, the strategy around Brandenburg was to build the most broadly capable mill in the Western Hemisphere and put it in the biggest plate market in the U.S. That is what we have got. We have built the capability set and we intend to go use it. So with those two focuses, then at least the third one, which is driving incremental returns for the enterprise. We have had the support from teammates, customers and our shareholders to put this project on the ground and now we just going to be more excited to start driving returns with it, and we are excited about what 2023 will bring. How do you guys see the global pig iron trade unfolding this year given the 25% reduction in 2022? Do you see supply chains having re-oriented at this point? Is there a reduced dependency on it given some of the new projects that have been announced by the blast furnace folks or others? Just what is the reconstruction in that market right now? Yes. I will kick it off, Phil, and then ask Noah Hanners over raw materials to comment on that. But I just want to point out because Noah was in the Vice President role over DJJ at the time. And again, as we have mentioned a few times on this call, the day that the Russians invaded Ukraine was the last day, we took a - any material from them. And so it required Nucor to pivot incredibly quickly. Noah and the entire DJJ team stepped up. Our teams across Nucor stepped up because of the long tenured relationships that we have around the globe, because of the relationships that DJJ has built with partners and customers in South America, we were able to pivot, move very, very quickly and bringing new supply into Nucor. At the same time, our teams have also technically figured out how to reduce our use and move from roughly what was about 10% of our pig iron use across the sheet group down to 5% or 6%. So the overall tragedy that is still continuing to unfold in Ukraine, has created a silver lining for Nucor and how we think about raw materials, our positioning strategy and our overall use and consumption. First of all, thanks for the question, Phil, and really for the opportunity to talk about our team and the performance through 2022 because I think it was really formative for how we think about employing raw materials going forward. So the short answer, I think, to your question about the balance of global pig iron supply is the Ukrainian - the invasion of Ukraine was really impactful. It was roughly 50% of the supply that went off-line when Russia invaded. But more important to us, the strength of our raw material models and the flexibility we have. If you think about how we operate about one-third of our raw materials are self-sourced between the DRI plants and our recycling group assets. So you combine this with what is really unmatched coverage of the market through our DJJ brokerage team and the flexibility of our mills in terms of what they can melt to make our products for our customers, and we can be extremely agile. So we are able to, as Leon described, quickly change our melt mixes, maintain our focus on value and use while minimizing our cost and making the products our customers need. So again, if you look back to 2022, it is a testament to this flexibility. We prepared for the invasion to the best of our ability, we had indications that was coming. We were able to quickly pivot, adjust our melt mixes at the mills, minimize our pig iron and immediately cease purchasing from Russia. So I'm extremely proud of our team for the 2022 performance. They executed and I'm also confident in our flexibility and the strength that provides us going forward. Thank you. And then in fabrication, you kind of gave us a range basically somewhere between the fourth quarter of 2022 and the first quarter of 2022, given profit, should we essentially split the difference there or is it going to be closer to one versus the other? And then within that, how are Deck and Joist prices holding up relative to the second half, because I know that they were historically strong. Yes. Phil, this is Steve. Thanks for the question, and that is been an outstanding segment that has really driven fantastic results for the year. It is been one of the key catalysts. So while we do see some moderation from that group, it is still very strong. I'm not going to guide you leaning one way or the other necessarily from 2021 versus 2022 or something like that. But you are seeing some moderation there, but still outstanding performance from that group well above. You should expect well above historic norms for that group as we head into at least the first half of the year where we have some visibility. Leon and team, I hope you are well. So I just want to drill down into the margin structure in the mill segment. If I look at 2021, your reported metal spread was about 720. And then if I look at the back half of 2022, it was about the same at 710. But your EBITDA per ton, at least based on my math, went from 410 to only 185. So that seems to imply a pretty big step up in conversion costs. And I know that there could be some galv start-up and other issues. But is that math roughly correct and can you just talk to how you see conversion costs trending into the start of this year. Curt, this is David Sumoski. Inflation has certainly been a factor for us in our convergence costs. It probably falls anywhere within $40 to $80, depending on the division. Couple of divisions would be higher than that, Gallatin being one of those, but those are outliers. So inflation has been a big factor. Two other big hitters we have to remember - well, two other big hitters are as we bought C.H.I. and ramped it up this year, we run slabs through that facility and the cost of the slabs go right directly into our cost of goods sold. So we had some pretty expensive slabs on the ground. So that was a pretty big hit year-over-year for our cost of goods sold. And then across all of our divisions, we had significant inventory adjustments throughout the year. And the cost of those inventory adjustments goes right into our cost of goods sold as well. So those three factors were pretty big, were very big, and that is why you see that big increase. Okay. Okay. That is helpful. And then second question is, if I look at Slide 7 on the expand beyond, you are talking, I think, targeted EBITDA across those assets of roughly $700 million. And it seems like they are making good progress on C.H.I. to get to the $400 million number. But can you kind of help frame like roughly like where we are in that progression? And then when you look at, I guess, those business segments, can you talk about growth potential within those? Or how should we think about maybe how much capital you would look to allocate M&A-wise into expanding beyond the core this year, if you have any preliminary views? Thank you guys. Yes, Curt, I will begin and let Steve sort of talk about the - as we think about through cycle EBITDA. But I will touch on your second question first. As we continue to think about the growth of Nucor. We are coming off two historic years. And really, over the last several years, our strategy has not changed. Our mission and our vision is very clear that is to grow our company, period. And we are going to do it in two ways: in the core and expanding beyond. You have seen our investments in the core. And while we are certainly not done, those will be probably more in line with what you have seen in terms of positioning strategies, moving into more galvanized, more prepaid, more higher value-added products as opposed to what we are doing in West Virginia in terms of a greenfield facility. But on the Expand Beyond piece, Steve, Alex Hoffman, who heads up our business development team and our executive team is focused on growing and looking in that expand beyond area. For those adjacent companies that have sort of steel centricity at some piece that are efficient manufacturers because that is really where we see the value set in coupling. That is one of the reasons why we were so excited about C.H.I. Again, I couldn't be more proud of Dave Bangert and the entire C.H.I. team for how they have performed through this year. And again, their EBITDA and where we sit today is so far beyond the models that we built out. So that focus for us is going to continue. We are going to continue to look to grow Nucor, to position Nucor well into the future and be generating significant revenues as well as our bottom line net earnings through the expand beyond businesses that we continue to acquire. Yes. Curt, I will just add a couple of comments there to what Leon said in terms of where we are. With these particular platforms, there is not a significant amount of capital other than what we have announced on the towers business to achieve the $700 million target that we outlined for these businesses. So we are well along that path, very proud of the teams that are in these four platforms. The work they have done so far to integrate into new for as Leon touched up in opening remarks has been very solid and I think they just underline what Nucor's business model really is. At our heart, we are a strong, diversified industrial manufacturing model. And we are able to leverage that model in businesses and across a broad spectrum of our portfolio to drive value. So if you are looking for how much money might be in new expand beyond platforms. As Leon said, we are a growth company and so we are not done yet, but these platforms that are established are well on their way to that $700 million figure. Good afternoon everyone. I wanted to explore a little bit the outlook and then ask a question about volumes, and I think they are a bit tight. But just start with the outlook in the Steel Mills, in particular. You talked to improve profitability on higher volumes and improved margins, specifically in the sheet business. So the higher volumes I get seasonally and off a pretty low base at 70% utilization. On the margin side, I mean, it looks like trending prices at 750 hot rolled and compared to Q4's average price of 960 looks like a tough comp. And costs have increased and there is deeper discounts on your quarterly context and monthly context. So I'm just trying to figure out if your guidance is more about the volume side or if I'm missing something on mix or costs? Yes. I mean, Timna I'm not going to get into the contract to contract comparison. But again, all contracts are not created equal. They are not all on a calendar year that are not all one-year contracts, and there are different escalators built in accordingly. And so again, we feel really good about our strategy. And that strategy really comes back to the pre-announcement as we were getting ready to announce West Virginia to build the most diversified capability set, not capacity. And so if you look at what the sheet group, in particular, is done this year, they have matched demand. They have matched the market in what was required and that flows through and you can look very quickly to see our EBITDA per ton and what we have been able to return back to our shareholders and our performance that I'm very proud of. If you think about our positioning as we move forward, we are going to match that. And my answer to the Gallatin question, that mill will have the capability to run at full steam come Q2, but we will be very mindful about how we bring those tons into the marketplace. So again, we are going to be very thoughtful about how we do that. Yes, Timna thanks for the question. The only thing I would really add if you look at the volatility we had from what we saw in really the second half of 2022, but if you look at where CRU stood in third quarter and then the drop in the fourth quarter and now what we are seeing now, it is a really short window. And I think that is to Leon's point, we have a long-term strategy. And in the short-term, you may see us do things from quarter-to-quarter based on what the market is happening. We chose very specifically not to participate in some of the spot market as heavily as we saw some of the lower pricing. So you would see some lower volumes, but we are a margin-focused company, long-term, as a group, as a sheet group, our goal, our purpose is to generate a return for our shareholders on our investment. So that would be the only addition I would have. Okay. I was just trying to understand the margin guidance on the sheet side, in particular, if that was a pricing or cost driven, but I don't want to press you on contracts. I understand that sensitive. So I guess I will switch to the second one. If you have anything else on the cost side, that would be great. But on the utilization at 70% in the fourth quarter, and one of your peers earlier today counting above 85% utilization. Should we think about that ramping up given all the positive commentary on demand that you are explaining, Slide 17 and the ramp-up of, of course, Gallatin and Brandenburg. I mean, is it reasonable to expect that there should be a commensurate increase with the new capacity coming on or to more normal utilization levels? I think you are going to watch that unfold. And again, I'm not going to comment on what our competitor strategy or positioning is. However, obviously, one of our competitors has got a new mill and a lot of assets sitting on the books, and they are going to do whatever they are going to do and bringing that mill up. At the same time, we are going to focus on what Rex said, in providing a return to the margin that drives our business. And so we will meet the demand out there. We are not going to chase tons or pull forward demand that isn't real. But again, I think what we are seeing in the indicator is that the sheet group is seen over the last two-months are very favorable. And I think that will continue, and you will see the uptick subsequently in our utilization rates as we head into the back half of Q1 into Q2. Thank you very much. Good afternoon Leon and Steve. Leon, I have a couple of questions. One is on startup costs and the other is on Corporate and Eliminations segment or line in your reports. First, on the startup cost, as you complete some of the projects and you ramp up the play mill, how do you see the start-up costs coming out in 2023, given the big increase that we saw to $250 million in 2022 versus $130 million last year. Any clarity there would be great understanding that you are always a growing company but any color would be useful. Yes. Carlos, and thank you for that comment. And that is where I would like to start where you ended. Nucor is very much a growth company and you do see different treatment of start-up costs from us versus some of our peers. Some of them like to make adjusted earnings, we don't view that as an adjustment. That is just part of what we do. We are a growth company. You are going to see that going forward from us, continued start-up costs, pre-operating start-up costs. It was $73 million in the last quarter. We expect it to be down just a little bit in the first quarter. And some of the variability as you start to model out the year, will have to do with spending and the pace at West Virginia. So you will have to just kind of stay tuned on that. But for the next quarter, you will see that come down slightly from the fourth quarter. Did that address your question adequately? Yes, definitely. And then the other question is on Corporate and Elimination. The report was 77.1 million in the quarter. If I adjust back for the tax credit and the tax, the change in the valuation allowance. I think I calculate - and I'm assuming that this is all on just the same figure pretax and after tax. I calculate that line would have been around $71 million negative - $71.4 million negative, which will be a substantial improvement versus the $441 million reported in the third quarter and $617 million negative in the fourth quarter of 2021. So I wonder if you can comment a little bit about that delta, which is definitely helped the quarter. And I assume from your guidance that it is not going to be such as a positive tailwind in the first quarter of 2023. Yes, yes, very much so. The components that go into that segment, the corporate and Elims number, you have got several different things, administrative costs, you have got interest cost and in compensation-related costs, the largest of which is profit sharing, which as Leon said, we are thrilled that our team earned almost $1 billion in profit sharing this year which will get paid out in March. But the big swing from last quarter to this quarter was really the inventory valuations that occurred in our intercompany elims. That is why it swung to the positive credit that you see. So that is what we don't expect to have going forward. That is going to be the biggest change between Q4 and as we head into Q1. And there is really two components to that. If you start to look into your model in a little bit more detail. So one part of that was the DRI losses we had, which, of course, wiped out any profits - intercompany profits between DRI. And the other part is really around volumes. And that was more pronounced in our downstream steel product segment than it was anywhere else. We shipped a lot, Carlos, toward the end of the year, even more than we expected. So that is partly why you saw a little bit of increased free cash flow from working capital as well from that factor. And just to close the loop here between Dave Sumoski commented earlier, it is one of the drivers of why sometimes it is a little complicated to look at our costs when you are looking at a segment and you are trying to dial into steel mill cost. Part of those elim numbers are actually falling out of that segment number down into the total corporate elims number as well. So it does get a little fuzzy when you are trying to look at. Yes, hi, thank you for taking my question. The first one on plate please. Can you explain a little bit the strategy, and it is kind of a question in three parts. The first one on the volume side, if I look at plate volumes for the year, they are around 1.5 million tons, usually around two million tons. So what is the target really with the new facility for 2023? And also, if you can talk a little bit about the mix, the target product mix and market mix for the new facility. The second kind of part of the question is more on prices. When you look at plate prices to explore, they are still really strong. Do you believe that the demand environment you are seeing is kind of warranting those elevated prices and now we are back to kind of a more normal kind of price/cost relationship or do you believe some normalization should still take place there? And finally, with those elevated prices domestically, how do you view the import risk. There has been a new trade case? How hard do you feel about that? Do you think the U.S. market is definitely well protected there. Alright. I'm going to begin and then I will let Al talk more specifically, but I want to begin with telling you our prices in plate are not elevated. And I do look forward to them returning to normal levels closer to $2,000 a ton. And so being a little facetious with you, Tristan, but we don't think they are elevated at all. We think we are in a supply and demand environment. And in a commodity business, demand will always dictate pricing. And so that is the driver. And so I would, again, tell you that they are not elevated. In terms of import risk, and you mentioned the trade case, actually all testified here not too long ago on that case, the ITC is found and upheld, the sunset review on those countries. And so the protections that are in place today, not just on pipe, but all of our products is so greatly enhanced from what we saw six, seven years ago. In 2015, for example, there was only about 50 or 55 trade cases that were won against countries found dumping or illegally subsidizing their steels. Today, that is closer to 150. And so regardless of administration, we have had great success in advocating for our industry and holding those countries accountable with countervailing duties or antidumping margins for bringing, again, not just plate, but sheet and rebar and other products into this country illegally. But Al, you want to touch on sort of that makes the strategy for Brandenburg, how we expect to ramp that up? Yes, it is a great question, Tristan. There is a lot to unpack there. I will talk through a few of it and then I may ask Caleb Strother, who is our Director of Commercial for Plate Structural Group to talk with a few more specifics. But to echo what Leon said, no, certainly not. We think plate prices are at a range where the market is bearing them, and they think they are fair and we don't see them as elevated at all. What we did with our order book or the way we bifurcated our order book through this year, we separated coil and cut-to-length plate from discrete plate. That was one thing we did. To make sure that the highly differentiated product like discrete plate that can only be made at the plate mill, collects the premium that is warranted versus some of the other products that can be more influenced by hot band pricing. And so that is been largely successful if you follow the pricing of both of those, and I know you do, you can see that we were able to decouple those too. So as we sit now, our order book, our mix on plate is about two-third discrete plate and about one-third coil or cut-to-length plate. And as Brandenburg comes up, Brandenburg's going to be mainly a discrete plate mill. It is got a sec mill that can run coil plate. That will be a highly specialized plate, very value-added. We won't run a lot of coil plate out of Brandenburg, it is discrete plate. So it is going to move our mix to about 75% discrete. We see that obviously is a good thing. You asked about tons. I will give you a rough accounting of the times during ramp-up year and then ask Caleb to chime in on some of the markets. But we are expecting somewhere in the 10,000 to 20,000 ton range of shipments in Q1 so that is primarily a ramp-up quarter. Second quarter probably in the range of 100,000 tons and then somewhere in the 200,000-ton range in the second or excuse me, in the third and fourth quarter. So somewhere in the 500,000 to 600,000 tons. I think we would expect out of Brandenburg this year. Obviously, the market will dictate part of that, but we would expect to be at run rate capable of capacity by the end of the year. So Caleb, maybe if you want to talk just a little bit about some of the market strategies and some of the areas we hope to penetrate with our broader capabilities. Sure. Thanks, Al, and thanks, Tristan, for the question. Brandenburg brings a whole diversified product mix that we haven't had with our plate group prior. When you are looking at plates up to 14 feet wide, 14 inches thick and 1,500 inches long, this helps support a lot of the initiatives that are going on the market. Dan touched on the IRA and the infrastructure package. Brandenburg is well suited in the middle of the country to help supply those customers with solutions that our plate group hasn't been able to offer in the past. Also with our announcement of Elcyon, you look at further investment in greening of the energy grid that is happening in our country, Brandenburg is well suited to supply the monopile plate that will be required our U.S. fabricators and as well as globally around the world for other fabricators. Alright. That is very helpful and just a quick follow-up. In terms of wind and renewable, how much of the percentage of demand or volumes could that be? The percent of the volume out of - well, I would just tell you, energy, roughly around 10% of our overall mix is probably where we see it. That could ebb and flow a little bit depending on demand and timing, but that is roughly where we are at as a company. Alright. That is really helpful. And if I may, just another one, also kind of big picture, but moving from plate to rebar. Can you discuss a little bit what you are seeing on the market more kind of near term, but also more medium term as you ramp up your new micro mail? And also, what kind of the time line - is summer 2024, the right kind of timing to think about this facility and the impact on the infrastructure bill, is it something you are looking at to kind of move meaningfully into Q3, Q4? Is that the right way to think about it? Good afternoon Tristan, this is John Hollatz. Thank you for the question. We feel our portfolio in long products is really going to benefit from what we see coming in 2023 related to the infrastructure bill, where the rebar market will grow by 1.5 million to two million tons per year. And we are planning on ramping up our mill in Kingman should ramp up about October of 2024, and Lexington in the middle of 2024. So we feel like we are well positioned to take advantage of that market. The other thing I would add, John, and Tristan, just in closing that, the positioning of Lexington and the overall micromill strategy is to locate in the growing regions in the Atlantic post in that where Lexington, North Carolina sits is going to be very key in the growth of that sector in that market with proximity to the lowest price scrap and again, the customers that will be supplying that strategy, as John pointed out and has been incredibly important for Nucor. That will continue to help shape and again, provide the returns that we have seen in rebar and quite frankly, of our long products. The other piece is you asked about the Infrastructure Act. We will take meaningful shape, probably second, third, fourth quarter, certainly in the back half of the year. But as Dan mentioned earlier, make no mistake, the order activity, the quotes, the interest in the bar group, our products Vulcraft for decking it is already begun. So we are already seeing the pre bids and activity already starting. So again, that is not just wishing and hoping we are seeing that activity. We are seeing some of the approvals in the bridge and highway programs actually get funding now, and that will have a meaningful and substantive impact. We estimate in most of the outside groups estimate for every $100 billion in infrastructure, there is going to be about five million tons of steel that will flow through. And again, the product breadth and offering that Nucor has today puts us in an incredibly advantageous position to serve that growing market. And this concludes our question-and-answer session. I would like to turn the conference back over to Mr. Leon Topalian for any closing remarks. Thank you. In closing, I just want to thank our team for a historic year in delivering the safest and most profitable year of Nucor's history. Thank you to our customers who enable our success. We appreciate the trust you place in Nucor with every order, and we will continue to work hard to earn your business. And finally, thank you to our shareholders. We take seriously the stewardship of the valuable shareholder capital that you entrust us with. Thank you for your interest in Nucor. Have a great day.
EarningCall_1444
Good morning, and welcome to Bread Financials’ Fourth Quarter Earnings Conference Call My name is Charlie, and I'll be coordinating your call today. [Operator Instructions] Thank you. Copy of the slides we will be reviewing and the earnings release can be found on the Investor Relations section of our website. On the call today, we have Ralph Andretta, President and Chief Executive Officer of Bread Financial; and Perry Beberman, Executive Vice President and Chief Financial Officer of Bread Financial. Before we begin, I would like to remind you that some of the comments made on today's call and some of the responses to your questions may contain forward-looking statements. These statements are based on management's current expectations and assumptions and are subject to the risks and uncertainties described in the company's earnings release and other filings with the SEC. Also on today's call, our speakers will reference certain non-GAAP financial measures, which we believe will provide useful information for investors. Reconciliation of those measures to GAAP are included in our quarterly earnings materials posted on our Investor Relations website at breadfinancial.com. Thank you, Brian, and good morning to everyone joining the call. We set ambitious goals in 2022, and I'm extremely proud of our associates for moving our company forward by executing on our initiatives to achieve these goals. I'll begin on slide three, which highlights several major accomplishments achieved in 2022, as part of our ongoing business transformation. To begin, we rebranded from Alliance Data Systems to Bread Financial. A tech forward financial services company providing simple personalized payment, lending and saving solutions to consumers. Following our multiyear corporate transformation, Bread Financial has emerged as a more modern, nimble and streamlined company backed by leading technology and custom platform solutions that empower today's consumer. Coinciding with our rebrand, we launched our direct-to-consumer, Bread Cashback American Express credit card and we branded our buy now, pay later platform to Bread Pay, which offers installment lending and split pay solutions to an omnichannel approach. We also rebranded our retail deposit platform to Bread Savings. These enhanced products provide industry-leading benefits and complement our existing suite of financial offerings, ensuring our customers across generational segments have access to payment and saving solutions. We continue to sign new iconic brand partners, including AAA and the NFL, while renewing valued long-term relationships like Victoria's Secret. We have secured renewals with brand partners representing approximately 85% of our year-end 2022 credit card balances through 2025, after adjusting for the anticipated sale of the BJ's portfolio. We also saw success with de novo program launches in 2022 such as B&H photo, which exceeded our initial performance and growth projections for the year. We look forward to working with our new and existing brand partners to drive incremental sales growth and customer loyalty through our sophisticated data and analytics capabilities, enhanced value propositions and comprehensive product suite. In 2022, we invested more than $125 million in technology modernization, digital advancement, marketing and product innovation. Major achievements included transitioning our credit card processing services to Fiserv, converting to the cloud and integrating Alberia, a state-of-the-art solution and enhances the productivity of our customer care and collections efforts. Our digital advancement continued to progress, as well as we expanded mobile and web-based customer servicing capabilities and launched a virtual card with web to wallet provisioning to provide our customers a more simplified user experience These upgrades supported our transformation, enhanced our strategic differentiation and are essential to driving operating efficiencies and innovation. We remain committed to ongoing technology investment with a focus on further digital advancement. As part of our investments, we increased our marketing investment in 2022 to bolster spend through joint marketing campaigns with our brand partners. Developing strong collaborative relationships with our partners has underpinned our decades of successful growth as these investments build loyalty with both our partners and their customers, as well as expand sales opportunities. Additionally, by leveraging our sophisticated data and analytics capabilities and efficient targeting channels, we were successful in driving new acquisition and engagement with our Bread Cashback American Express Credit Card, Bread Pay and Bread Savings offerings. We will continue to invest for the future to deliver value for our brand partners, customers and shareholders. Finally, I'm proud to announce that Bread Financial was recognized for a prioritization of environmental, social and governance across our entire business earning a spot-on Newsweek's 2023 list of America's most responsible companies. Our commitment to advancing our ESG strategy, objectives and accountability is evident with the organization and remains core to our sustainable business practices. Turning to slide four, we are pleased to have achieved our 2022 financial targets, driven by organic growth from our existing brand partners, as well as addition of our new brand partners and product offerings. Average loans grew 13%, compared to 2021 revenue growth exceeded average loan growth at 17% year-over-year. Pretax pre-provision earnings increased 19% versus 2021, highlighting the quality of the growth we are generating and the underlying value we are creating. We remain disciplined generating more than 200 basis points of positive operating leverage for the year as we managed our expenses in alignment with our revenue and growth outlook, while continuing to invest in our future. Our net loss rate of 5.4% remain within our full-year guidance range and below our historic average of approximately 6%. Along with accomplishing our 2022 targets, we significantly strengthened our balance sheet and bolstered of financial resilience through greater product and funding diversification. We increased loss absorption capacity and growth in capital and tangible book value. Retail deposits on our Bread Savings platform increased to $5.5 billion or 72% year-over-year. We plan to build on these achievements in 2023 through continued execution of our long-term strategy. Moving to slide five, I'll highlight some of our most recent business development success. I am pleased to announce that we have signed a new long-term credit card relationship with Hard Rock International, a well-recognized hotel, casino and restaurant operator. Hard Rock attracts a broad demographic given its diverse offerings, further expanding our reach across generations. We will offer Hard Rock customers a new way to pay, while incenting loyalty and brand affinity through our co-brand credit card. During the quarter, we announced a new agreement with the New York Yankees. This exciting relationship reward’s Yankee fans for their purchase and provides enhanced benefits to our New York Yankee's co-brand credit card, while further diversifying our brand partner base. Also during the fourth quarter, we signed a multi-year renewal with long-term partner Helzberg Diamonds underscoring our strong market share position in the jewelry space. Helzberg Diamonds has more than 100 years of diamonds expertise and operates online at over 200 stores nationwide -- and 200 stores nationwide. We will continue to leverage our advanced data and analytics to enhance the shopping experience to Helzberg's customers. Turning to Bread Pay, we continue to add new brand partners to our platform and importantly, we have now extended nearly 50% of our current loan origination volume with new long-term renewals. Because these contracts historically have been short-term in nature, having long-term extensions will reduce volatility and promote long-term sustainable growth. Additionally, our strategic relationship with CECL continued to outpace our expectations with now more than 200 live merchants and installment loan origination volume exceeding our initial goal. We are pleased with our many accomplishments in 2022 and plan to build on this momentum in 2023. Our business development pipeline remains strong and we are confident in our ability to grow responsibly in 2023, despite a more challenging macroeconomic landscape. As always, we remain vigilant and responsibly driving sustainable profitable growth. Perry will outline our specific 2023 financial targets, which include continued strategic investments aligned with quality and revenue -- quality loan and revenue growth. Our 2023 outlook assumes continued inflationary pressures and gradually rising unemployment levels. Headwinds that we expect will result in a full-year net loss rate above our long-term historic average of approximately 6%. This corresponds with our expectations that net loss rate will hover above our historic average during more challenging economic periods and drop below our historic average during more favorable economic periods. With three decades of experience, our differentiated and tested underwriting and credit risk modeling is purposely structured to navigate the full range of economic scenarios, focused on producing positive annual earnings and a strong risk reward margins even during periods of economic stress. With the changes we have made over the past three years to strengthen our credit profile, we remain confident in our long-term guidance of a through-the-cycle average net loss rate below our historic average of 6%. Our seasoned leadership team is experienced in managing through credit cycles and every cycle is different. Some factors like inflation are impacting all consumers and cannot be fully controlled or mitigated. We will manage what we can control. In these instances, we run our business with a long-term focus as we have done effectively in previous downturns. We have and will continue to proactively adjust our underwriting and credit line management to account for the anticipated challenges faced by consumers. We manage our business with strong governance and controls intact and remain aligned and confident on our objective to deliver long-term value for our stakeholders. Thanks, Ralph. Slide six provides our fourth quarter financial highlights. Bread Financials’ credit sales were up 16% year-over-year and $10.2 billion. Average and end of period loans were each up 23%, driven by our new program additions, as well as new products and organic growth from existing brand partners. Revenue for the quarter was $1 billion, increasing 21% versus the fourth quarter of 2021, resulting from higher average loan balances and improved loan yields. While total non-interest expenses increased 28% as anticipated. As we signaled previously, EPS was materially impacted this quarter by the higher provision for credit losses, reflecting seasonal loan growth in the quarter, coupled with the required upfront CECL reserve build from the acquisition of the approximately $1.5 billion AAA loan portfolio. Turning to slide seven, I'll review our full-year 2022 financial highlights. Bread financial credit sales were up 11% year-over-year to $32.9 billion and average loans increased 13%. Revenue for the year was $3.8 billion, an increase of 17%, compared to 2021, while total non-interest expenses increased 15%, driven by portfolio growth, inflation and ongoing investments in technology modernization, digital advancement, marketing and product innovation as Ralph had discussed earlier. Income from continuing operations was $224 million and diluted EPS from continuing operations was $4.47 for the year, both of which were materially impacted by the higher provision for credit losses in the year as a result of our strong loan growth, portfolio acquisitions and a higher reserve rate. Looking at the financials in more detail on slide eight. Total interest income was up 30% from the fourth quarter of 2021 resulting from 23% higher average loan balances, coupled with improved loan yields. Non-interest income, which primarily includes merchant discount fees and interchange revenue net of the impact from our retailer share agreements and customer awards was negative $97 million. Total non-interest expenses increased 28% from fourth quarter of 2021, driven by three primary factors: First, card and processing expenses related to incremental card issuance volume; second, information processing and communication as a result of the transition of our credit card processing services and other software licensing expenses; and third, higher employee compensation and benefit costs. Additional details on expense drivers can be found in the appendix of the slide deck. Overall, income from continuing operations was down $195 million for the quarter versus the fourth quarter of 2021 as the improvement in pre-tax, pre-provision earnings or PPNR was offset by a higher provision for credit losses in the quarter. Including the previously discussed upfront CECL reserve impact from the AAA portfolio acquisition in the quarter. Taking out the tax and provision impacts, we are pleased to report that our PPNR improved 13% year-over-year making the -- marking the seventh consecutive quarter that we have generated year-over-year double-digit growth in PPNR. As we have said, we remain focused on making responsible decisions to produce quality earnings. Turn to slide nine. The left side of the slide highlights our earning asset yields and balances. The fourth quarter loan yield increased 80 basis points year-over-year, driven by the increases in the prime rate, but decreased 120 points sequentially, due to seasonally higher balances in the quarter the addition of the lower and yield, higher quality AAA portfolio and an increase in reversals of interest and fees revenues from higher gross losses. Net interest margin increased 30 basis points to 19.1% year-over-year as the benefit from loan yields more than offset the increase in funding costs. On the liability side, we saw funding costs increase in the fourth quarter in line with our expectations given the Fed interest rate increases through December of 2022. As you can see from the stacked bars on the bottom right, our direct-to-consumer deposits continue to grow and now represent $5.5 billion or 26% of our total interest-bearing liabilities. We expect that our retail deposit balances will continue to increase providing a stable funding base as retail consumer deposits become even more meaningful portion of our funding over time. Moving to slide 10, and starting in the upper left with delinquency rate. The fourth quarter rate of 5.5% was slightly below the third quarter rate, following typical seasonality. On the upper right, the net loss rate was 6.3% for the quarter slightly better than our earlier projection, due to lower-than-expected losses in November. The loss rate in December of 6.7% was more in line with our expectations given continued payment rate pressure. If we think about where the consumer is today, we have to look at how we got it. Earlier in 2022, we still saw some of the benefits from the late 2021 stimulus aid coming through in terms of both spend and very strong payment rates. If you look at a trend line from our low point in 3Q ’21 to today, you could see the upward movement or normalization of loss rates from both the wind down of stimulus, which has largely run its course and the influence of elevated inflation. We saw lower scoring and lower income cohorts normalized first. However, given the broad impact of inflation, we're seeing impacts across the full credit spectrum and all income groups. As you would expect, we continue to proactively manage risk reward decisions at the margins for both new account underwriting and existing account line management. This is an ongoing and evolving as the macroeconomic environment unfolds. Moving to the bottom left, the reserve rate increased 10 basis points sequentially from the third quarter to 11.5% as a result of continued elevated inflation increasing consumer debt levels and weakening macroeconomic indicators pulling down the base case scenario outlook. This was modestly offset by the addition of the higher quality AAA portfolio and seasonal transactor balance growth in the fourth quarter. Our intention is to maintain a conservative weighting of economic scenarios in our credit reserve model in anticipation of the increase in macroeconomic challenges and the expected potential impact on our credit performance metrics. We estimate that our reserve rate could increase up to approximately 100 basis points, due to the continued macroeconomic trends, seasonality and the impact from the anticipated sale of the better credit quality BJ's portfolio. In nominal dollar terms, we would expect a meaningful decrease in our allowance balance and therefore a provision for credit losses released in early 2023, again due to the anticipated sale of the BJ's portfolio, as well as projected seasonal decline in loan balances from year end. Our credit distribution improved from the third quarter with economic consumer headwinds offset by the benefit from the AAA portfolio acquisition, we would expect our overall portfolio or overall proportion of 660 plus advantage score customers to move down when we exit the BJ's portfolio. A fundamental element built into our business model includes having controls in place to manage our risk tolerance with the objective of ensuring that we are properly compensated for the risk we take to underwrite and manage our portfolio. We closely monitor our projected returns with the expectation that we generate strong risk adjusted margin above fewer levels. As Ralph alluded to previously, we remain confident as a management team in our ability to manage for credit risk and drive sustainable profitable growth through the full economic cycle. Slide 11 provides our financial outlook for the full-year 2023. For the full-year, average loans are expected to grow in the mid-single-digit range relative to 2022. Our expectation includes projected new and renewed business announcements, visibility into our pipeline, the anticipated sale of the BJ's portfolio and our current economic outlook. The range is contingent on credit strategy actions that will lever on macroeconomic conditions. We expect revenue growth to be consistent with average loan growth in 2023. Excluding the anticipated gain on sale, with a full-year net interest margin similar to 2022 full-year rate of 19.2%. The first quarter NIM is expected to be below our full-year guidance given the inclusion of the lower loan yield BJ's portfolio and a larger headwind from the reversal of build interest and fees related to expected elevated first quarter credit losses. Our outlook assumes additional interest rate increase by the Federal Reserve will result in a nominal benefit to total net interest income. We expect to deliver nominal positive operating leverage in 2023, excluding anticipated gain on sale. As Ralph highlighted, we will continue to strategically invest in our business to fuel growth opportunities and create operating efficiencies, while balancing these investments with responsible revenue growth in order to achieve sustainable profitable growth. First quarter 2023 total expenses are projected to be sequentially down from the fourth quarter of 2022 benefiting from seasonally lower transaction volume and lower marketing expenses. At this time from a dollar perspective, we expect the second half 2023 total expense to be flat to down from the first half of the year, driven by lower intangible amortization expenses and improved operating efficiencies related to our technology modernization efforts. We anticipate the full-year 2023 net loss rate will be approximately 7%. As you can imagine, there's a broad range of outcomes for net charge-offs for the year based on potential economic scenarios. Given persistent inflation and rising interest rates, borrowers are making decisions to pull back on discretionary spend and drawing down on savings, pressuring their ability to pay. Despite low unemployment, moderate income households are increasingly noting payment difficulties during the collections process. Our outlook assumes inflation remains elevated and that these pressures will persist throughout 2023. At the same time, our outlook contemplates a gradual increase in the unemployment rate in 2023. We will continue to closely monitor macroeconomic indicators as we gain clarity on the Fed's efforts to tamp down inflation. We'll update our expectations accordingly. We expect the first half 2023 loss rates to trend upward given the current inflationary pressures, as well as the impact of the sale of the BJ's portfolio. Our first half net loss rate is projected to be above 7% inclusive of the impacts from the previously discussed customer combinations we made in the second half of 2022 in connection with the transition of our credit card processing services. Finally, we expect our full-year normalized effective tax rate to remain in the range of 25% to 26% with quarter-over-quarter variability to timing of certain discrete items. Looking forward, we intend to host an analyst event later this year, we will further highlight what we believe are the strategic differentiators and competitive advantages of our business model, including the capital generation potential to create. At that time, we plan to provide new long-term financial targets, as well as more detail around our capital priorities and capital allocation going forward. Regarding current parent capital levels, our TCE to TA ratio temporarily dropped in the fourth quarter of 2022, due to the timing of the acquisition of the AAA portfolio. Given the anticipated sale of the BJ's portfolio, our TCE to TA ratio is projected to increase to a level above the 3Q ‘22 figure of 8% after the sale. In keeping with our business transformation over the past three years, we made strategic decisions to enhance our financial resilience as indicated on slide 12. We improved our credit quality, product and funding diversification, loss absorption capacity through our loan loss reserve and capital positioning and increased our tangible book value. Our tangible book -- tangible equity plus credit reserve ratio as a percent of loans is up nearly 200 basis points since 2020. Our parent level debt is downward in 33% over the same time period. These enhancements and improvements to our underlying credit portfolio mix strengthen our confidence in our ability to sustain more challenging economic outcomes and outperform our historical results through entire economic cycle. Our experienced team will continue to manage our portfolio proactively. We're utilizing our recession readiness playbook for both new and existing accounts with a heightened focus on open to buy authorizations and helping consumers manage their credit lines and balances in a healthy manner. We believe that our improved risk profile coupled with our more diverse portfolio in brand partner base make us better positioned than ever to manage through a recessionary period. We look forward to building upon our successes from 2022 and we'll continue to make strategic decisions to create long-term sustainable value for all our stakeholders. Of course. [Operator Instructions] Our first question comes from Sanjay Sakhrani of KBW. Sanjay, your line is open. Please go ahead. Thanks. Good morning. I guess, I have some questions on the loss assumptions in reserve rate. Perry, you talked about the reserve rate possibly going up another 100 basis points in 2023. So I'm just making sure I got this right. So you think by the end of this year we're probably closer to 12.5% and then the 7% charge-off rate for the year. Can you maybe just separate what the processing, conversion impacts are versus sort of the deterioration you're seeing as a result of normalization? Thanks. Sure. Thanks, Sanjay. So let me start with the reserve rate first. We're always trying to give our best thinking based on our current visibility into our portfolio and the economic landscape. As I mentioned earlier, we expect the rate to increase in 2023 given the sale of the BJ's portfolio and potentially continued economic weakness. So when BJ's exit, that's going to cause a step up in our reserve rate, because today that's on the portfolio at a lower than the current average that we have. And then you look at the -- I would say that a lot is going to happen in the first quarter, plus then you've got seasonal impacts that can also affect the first quarter. Specifically regarding the risk overlays, I think you guys could see that we are proactive in getting ahead of what we've seen to be future potential weakness, which is what the CECL economic risk overlays help us to achieve. And one thing we recognized early on was that all industry loss models have been calibrated historically on changes in unemployment and those unemployment led recessions. This elevated inflation environment that's currently creating strain on consumers is not what these models are calibrated. So it requires a different degree of judgmental overlays, which is when you hear us talking about, hey, we're leaning into more of those more severe scenarios, which update -- for our severe scenarios. The severe has a -- reaches an unemployment rate of 7.8% over the next 24-months that we’re at peaks. And then the severe reverse adverse peaks at 8.9%, but I don't think those are realistic outcomes of what's going to happen, but we leaned into those for weightings to care for that inflation component. So you can decouple, let's say, there's a judgmental piece, but then there's also the unemployment. So this is kind of a new environment for these models to care for. So when we get to the end of this year, we're thinking that we're going to exit the year with a mid to high 4 % range for unemployment. So that's kind of the -- sorry, I gave you probably a lot more on that with the reserve rate. And then I'll answer the second -- the first part or second part of the 70% loss outlook, that's an increase of 150 basis points to 175 basis points year-over-year. And there's three components that are in that, right? There's the macroeconomic pressure that we're seeing in the consumers and we expect throughout the year there'll be the continued impact of inflation that maybe in the back half of the year that starts to abate, but then you start to pick up some elevated unemployment. Then you also have the second piece in there that's contributing to the increase of 150 basis points to 170 basis points is BJ's, which has a lower NCL rate than the rest of the portfolio, that's going to cause over the lift. And then the third piece for us is we do have some trailing conversion relating -- related items that from customer accommodations that was simply the timing of credit losses that would have been in 2022 that are pushing into the first half of ’23. Okay. And just maybe one follow-up question for Ralph. Just on the processing conversion, I'm just curious, are all the residual impacts over at this point, all the kinks ironed out. I'm just wondering if we should think about anything else? Thanks. Hey, Sanjay. How are you? I think a lot of the growing pains are in the rearview mirror. And now we're going to reap the benefits of the -- of why we moved quicker to market, better capabilities, less expensive to operate. So unfortunately, we have these kinks, but I think a lot of that is an overview mirror. And we're focused on continuing to stabilize the system and then take use of all of the capabilities that we signed up for. Thank you. Question on your target capital ratio. What do you -- what is -- do you have a formal target? And when do you expect to -- when do you target reaching that target? Yes. So what we've been communicating is that we're striving to get to a 9% TCE to TA ratio is a good low-end mark. The first priorities of our capital has remained to provide in support profitable growth. And then the second priority is to pay down debt. And we will provide more information about our capital priorities and plans at the Investor events later this year. Thank you. And I would expect that we wouldn't see buybacks until you hit that or share -- capital return until you hit that target. Is that there? I don't want to give specifics, but again our priorities are to support our growth, get our capital levels up and then start to pay down our debt. Thank you. And then can you give any color on the competitive environment? There has been a lot of portfolios. Obviously, that have changed hands? Are you guys have resigned a lot? You've added a lot? What's going on with the competitive environment and the returns that you and your competitors are requiring for deals? I think no matter what the economy is in competitive environment is always, always hot and that never changes. So that never changes. But when we look at things, we look at things saying, can we grow the portfolio for the partner? Can we do it profitably and does it contribute to growth for us in a right -- correct way? That's how we look at portfolio. So portfolios changed hands, the portfolios we signed and acquired, we have a lot of confidence that we'll grow those portfolios. We'll grow them responsibly and we'll have good consistent growth. Yes. Great, thanks. And one of the things you talked about a little bit in the prepared remarks was the idea of consumer spending. Could you talk a little bit about how you, kind of, formed your expectations for receivables growth in terms of what you're seeing in consumer spending and payment rates and how those two interact over the course of ‘23? And I've got a follow-up. Yes. When I started that, I'll ask Perry to chime in. So we saw a good consumer spending in the -- we're seeing good consumer spending in January. But given the environment, there is pressure on sales that will offset some of the payment rate improvements. Just the reality of the macro environment we're going into. Yes. And I'll add into -- on to what Ralph just said. With that context of decelerating spend, consumers making choices within category to deal with the inflation. And then there's a rising cost of debt overall for them. They're pulling back on spend too. So we do contemplate that coupled with -- if you think about elevated losses -- credit losses through the year, that also dampens your growth speed as it drops 1.5% for you -- were the prior year that's in peach growth by 1.5%. And then on top of that, we're being more thoughtful about credit strategies and when you pull back online and underwriting, so that affects that and then as well it may throttle what we do with marketing, because the marketing returns look a little different for certain cohorts now. So there's a combination of things that go into our receivables outlook and all those things are contemplated. And the last thing I'll say is our book is changing and with the spend shift to non-discretionary to essential. Years ago, we would have been able to catch that, because we didn't have the products. We now have the products and co-brands and buy now, pay later and other things that are and direct-to-consumer, we're catching just general spend that we wouldn't have bought that before. Brand launches and new products are going to also help us drive sales growth over the course of the next year. Great. And as a follow-up, you mentioned kind of an unemployment outlook of 4.5% to upper 4s. How do you think about the variability around that if unemployment is either better or worse than that? And as we sort of think about the economic performance over the -- just beyond ‘23 as well? Yes, you know, unemployment is always a leading indicator of credit worthiness. So if the rate is better, we would expect credit to perform a little bit better. Obviously, if the rate is worse, we would expect it to perform worse. But we don't expect a spike in 2023. I think we're feeling what we've forecasted, we feel that is where it would be -- that's an exit rate for ‘23 that will impact ’24. Thank you for taking my question. I wanted to ask about late fees, so two-part question. The main one being just your overall thoughts about that given potential regulation that might challenge late fees. So just your thoughts on what the potential impact is and how you can maybe around that? And then a follow-up question is, so saw that this quarter, part of the yield decline quarter-over-quarter was from the reversals of interest and fees. So just wondering if you might be able to quantify that and what are your thoughts on that for 2023? Thank you. Yes. It wouldn't be an analyst call without the question about lease fees. So I'm happy to address it. I look at this as no different than Card Act. The industry was able to adjust. We adjust it accordingly, and we'll read into any regulation that is out there and we adjust accordingly around this. So we’ll say that as we think about late fees and any other regulatory changes, we have the ability to work with our brand partners to negotiate -- renegotiate terms if that's appropriate. So -- and there's other levers to pull, so that's -- we'll adjust accordingly just as we do with Card Act. Perry, you want to take the second? Yes. So as it relates to net interest margin, which is where late fees reside for us. When we see some delinquency increasing, you see the late fees materialize in net interest margin early and then when the delinquency manifests itself into elevated charge-offs, the reversal of some of those interest and fees occur in that period. So if you have a period where you're going to be above 7%, which is what we've indicated for the first half, you should expect that you're going to have some more reversal of interest and fees impacting that quarter relative to the prior quarter where losses were lower and you had less interest and fee reversal, so you actually had a little bit higher net interest margin. So that's going to be the dynamic throughout the year, and that's normal when you're going through periods of rising and falling delinquent the charge-off follow-up. Hi, thanks for taking my question. Perry, I just wanted to dig into the new loss guide. I think a lot of your competitors are still at or below their cycle averages and you're not guiding to something that's above that. I know we've got the noise coming through the portfolio, but you talked about some of the changes you've made over the past three years. How you've kind of enhanced the credit profile of that book. Just wondering what gives you confidence that that's going to drop back down to a below 6% level by the end of this year after this year? So I'm going to make sure I heard the question correctly. I think there's two parts. One is, why are we guiding higher? I mean, I think our -- the increase in basis points is probably in line with what we're hearing across the board. What we're seeing with our portfolio is we did normalize faster. And it's simply -- every company has a different composition of its portfolio. We're more a full spectrum lender. And as we communicated well over a year ago, we expected normalization to occur faster in our portfolio as consumers use their stimulus early and then that would start -- and they would normalize faster. And that has happened. And then as you mentioned, we do have some noise in our numbers, because of the BJ's departing and then some trailing impacts of timing of losses from customer accommodations that we did. But the -- when we talk about the confidence to get at or below, I think I heard you say at or below 6%. I think the thing is to have a 6% handle back on the back half of the year, it's because we do have front-end of the year noise that with the economic assumptions, I think -- again, there's a range of outcomes for the second half of the year, depending, I mean, if it's a mild year, if inflation starts to abate and then you have a slow increase in unemployment, I think that where things fall, the 6% average that we talk about is through the cycle. So you're going to have periods where you're below 6%, years where you're below 6%, then you're going to have years when you're above 6%. And when you're in a recession environment, you've got to be above 6%, if you're going to have a through-the-cycle average of 6%. And that's where we are. And I think the question that is for all of us is, okay, how long is this recession environment where it gets officially labeled with that or word or not, how deep does it go and how long does it stay right? Because it mild and short, then you get back towards that the reversion to the mean faster. Yes. I would say the thing to remember is we have improved our portfolio over the last three years. But our portfolio is still a bit riskier than our competitors, because we underwrite deeper. That said, we get paid for that risk and managing that risk as we move forward. So although we've improved our portfolio, we are still casting a wider net than others, and we get paid for the net that we cast. Got it. Thank you. And then just in terms of the credit sales this quarter, just wondering how much of the boost that you saw at the credit sales was driven by AAA? Yes. That was a significant amount of the increase. I mean, there was a slight increase in credit sales if you were to exclude AAA. Thank you. Good morning, Ralph and Perry. Perry, I wanted to wanted to follow-up on your comments around legacy credit models having been built around the concept of rising unemployment and not necessarily some of the inflationary pressures that consumers are facing? There's a view that delinquencies are going to continue to rise, but because labor markets remain exceptionally strong, we'll see them flattened out once we get to sort of the “normalized pre-pandemic levels”. Are you expecting given that point that you made that delinquencies could continue to trend higher, sort of, above normalized levels, because of these inflationary dynamics even though labor market conditions could still remain pretty strong. Just want to make sure I understood what you were -- the point you were making correctly? Yes. The point I was making on the models was more on loss forecasting models, not credit underwriting models. Credit underwriting models take into account think that the consumer level and taking a whole host of attributes of the consumer that do care for things like you've mentioned income, gainful employment, their debt they have on other issuers. So that all goes in on that. But yes, I mean, you raise exactly the -- one of the key points and why inflation is that the thing the Fed is trying to tackle it is a regression type tax, right? And so it’s moderate income to middle income families are feeling the pressure of that. So yes, while they're gainfully employed and yes, while there is wage growth that wage growth is not keeping up with things that are putting pressure on their families. And you see that with some increasing leverage and all of this impacts eventually ability to pay, and that's where customers can fall behind. And if you even think about inflation as what we're seeing today, while it's moderating a little bit, it's -- some of it is -- there's good news in there, but it's really driven, because there's lower fuel prices and lower used in new car prices, which certainly helps people own cars, but not everybody does. But on the flip side, shelter cost, food prices and utility costs are up significantly month-over-month and year-over-year. So while inflation abating, this is still concerning for most American’s even wilder, like you said, it's a job full environment and they're doing their best, but they're making choices on spend. So why I think you're starting to start to see some deceleration in overall spend, and we see some shift from discretionary to nondiscretionary, but all these things put pressure on folks. Understood. That's super helpful, Perry. Thank you. And separately, Ralph, I wanted to follow-up on your late fee commentary. I appreciate all the color. But I wanted to ask, if I could follow-up on the comment you made last quarter that the safe harbor you thought surrounding late fees was more likely to be reduced rather than eliminated. Is there any way you could give us an update there and maybe frame the potential magnitude of any reduction or impact that you think we could, see? You know, I know what you know from the CFPB, that was just -- what I would suspect that happen in the third quarter. I don't want to guess on what will happen. Whatever will happen, we're ready for it. We will lean into it, and we will manage accordingly. Thank you. Our next question comes from Mihir Bhatia of Bank of America Merrill Lynch. Mihir, your line is open. Please proceed. Excuse me. Good morning and thank you for taking my questions. I wanted to go back on to the credit guidance. And following up a little bit on Jeff's question, earlier. I just wanted to better understand the reason you have a high degree of confidence that the back half of ‘23 would be below 7% at least. Right, just given your implied guide of 1H above the 7%. So like given the high unemployment, you have BJs coming out. I understand you have some noise in the first half, but if I recall, that's about a 30, 35 bps impact there. Why would the back half come in below the first half, just given the macroeconomic pressures you are pointing to, right, with unemployment increasing throughout the year? And then relatedly, just in terms of your delinquencies and losses, like when do you expect delinquencies to peak and in terms of losses, given you've normalized faster than peers, do your losses peak before your peers who've all talked about that happening maybe in 2024. Any additional color you can help us with some of that. Thank you. Yes. So I want to be more clear, right? When we say the losses could be approximately or around 7%, that does not necessarily imply that the back half of the year will be significantly below the first half of the year. So it could still have a seven handle on it, it could be slightly below, it could be still slightly above or it could be flat. So I want to moderate the expectation that the second half will be materially lower. And I think you said it, there's a lot of economic uncertainty in the back half of the year and what continues to happen with inflation and unemployment. So I think there's a lot of speculation and we'll continue to update those expectations as we march forward. In terms of normalization, will we peak sooner I hope so. I think that -- so normalization of the higher end consumer is lagging. And when you think about the way when you underwrite with where we do the full spectrum, we manage losses very carefully and at a -- in line carefully where they -- you manage a low line with a lot less open to buy, compared to if we were in that super prime space, we have large lines, lots of open to buy. So when unemployment hit’s you're taking for a large line for us, you don't have as much open to buy. So as unemployment comes through, we have less severity risk is the way to think about that. So we may be less volatile. Hey, good morning. Thanks for taking my questions. Most have been answered. Perry, I guess I just wanted to follow-up a little on the NIM outlook, which is effectively flattish from fourth quarter throughout the year. I mean, I believe, historically, the company has always had, sort of, a net asset-sensitive model. And notwithstanding the reprising rates, I'm wondering, given the fact that deposit funding has continued to increase as a part of the mix, and we've successfully had a number of months past now where we can flatten out that the impact of the abrupt changes, the abrupt Fed rate rises and passing it along to consumers? Why wouldn't throughout this year, especially if we're not looking at any surprise increases from the Fed beyond the current outlook, why wouldn't there be a net positive impact in NIM? Is it primarily related to expectations at late fees first get reversed out with higher losses and maybe tempering, kind of, the late fee modeling as well based on what the CFPB might propose? What I would say is that the -- our outlook doesn't contemplate anything with the CFPB changes, because, as Ralph said, we can't speculate from what that means. But as it relates to net interest margin, you kind of touched on it, is we have been slightly asset sensitive. Our objective is to be close to neutral. And then as you think about NIM, there's many components from the asset mix, meaning the product mix, risk mix that goes in there and then when you enter a period of rising loss as you kind of said it is that the increase in late keys that you get or rollover is partially dampened when the losses come through because of the reversal of billed interest and fees. So it's all those things together. And then on top of that, we will have a changing funding mix throughout the year as we work through our debt stack and then you continue to shift to more deposits and things. So we're just giving guidance for what we think is a good way to model a base case for it. Understood. Appreciate the detail. And then just a quick follow-up. I know and I'm sure on the upcoming investor event, what will get updated background on, kind of, the vertical mix and other ways to sort of slice and dice the portfolio profile. But I noticed in the slides on new signings, there was another jewelry vertical retailer involved. Can you update us on kind of what percentage of balances are associated with that vertical, which has always been so prominent for you? Great. Thank you so much for taking my questions. I want to talk about the spending trajectory throughout 2023. And do you think it would make sense that the consumer would continue to slow their spending given what we're seeing in inflation coming down, because that's going to hurt nominal dollars, right, the grow-over effect of nominal dollars being dampened and really, the fact that would you expect spending to slow down through the period before up until we hit peak unemployment? And then I just have a follow-up. Thanks. Yes. I think that's -- that is our speculation a little bit as we're starting to see some decelerating spend. So I think when you think about that, that's impacting the individual consumers, as we talked about earlier, if you think that their utilities costs and food costs have gone up $100 in a month, where they've got to slow down spend elsewhere. So I do think that's a factor. For us as a company, we've continued to add new partners in 2022 and increase our marketing. So for us, we continue to see some overall spend growth -- originations growth even with the departure of BJs. But that -- and that is a -- it was a high transactor portfolio. So for us, that will slow our growth a little bit more than what it might have otherwise. But overall, the consumer, again, is still -- I think we said earlier, so gainfully employed, jobs to be had, small businesses are hiring even though you're reading about layoffs of big companies, there's lots of jobs out there. So that's what gives me encouragement that we're going to move through what would be more of a mild economic scenario. Yes. And I kind of mentioned it before, the shifts in our portfolio help us maintain spend, right? So if they move from discretionary nondiscretionary, we have products and services that the spend will be sticky to us. Great. Great. I really appreciate that. And if we -- I just want to walk through this formula with you guys. If you think about growth math and the fact that a lot of -- you and your peers have seen some really significant growth over the last few years that puts that kind of growth math seasoning pig-through-the-python dynamic, right? On the front book, but if we have unemployment rising, that would affect the front and back book. And so I feel like that would have almost like a doubling of -- not a pure double, but an increased additive effect on the net charge-off rate, if you have the pig-through-the-python and the back book is getting worse because of unemployment. Does that make sense to you or am I getting something wrong? No. I think in general terms, sure. But I'll speak specific to us. When you think about the growth that we've taken on over the past year, a good chunk of that was due to two portfolio acquisitions of the NFL and AAA in 2022. Those are already seasoned portfolio. So when you hear others talk about all this growth and they've got vintages, they're going to get peak losses in the next 24-months. That's not the case for us, because there came in season, we were taking losses in the first month, they were on the book. So start with that for us. And then if you think about the product mix, that also influences that growth map seasoning concept, because of the degree that we have private label cards, they start to season and peak in the, say, month 12 to 18-months, whereas many of those co-brands and other things peak 24 to 36-months. So ours within the first 12 to 18-months, we peaked in season. So we season a lot faster. Yes. I think the other thing I would say, too, is we haven't been sitting still. We've been proactively managing the back book and the front book with the right line assignments, right treatment for card member underwriting for the right vantage score. So we've been managing our recession handbook for the last 2.5 years. And so as I think about it, it puts us in good shift to know what's in the book and know where to focus. Great. No, that's really, really helpful. Ralph, maybe just really quickly one more for you. Just you have really great co-brand and private label portfolios. How do you see the dynamics playing out between the two? And as far as net charge-off rates and where you may decide to pull back in your underwriting one versus the other in the downturn? Thanks so for everything. Yes. So it's the private label portfolios have terrific margins, but they also have a little bit more risk in them. While the co-brand portfolios have good margins, but the risk is less. So if you think as you go into the economy, we certainly want to be fair with all our partners. It's important that we work through and make sure that we are doing the right thing by all our partners. But to me, it's really a balanced approach and making sure that we're taking the right risk for the right reward. Good morning, guys. Thanks very much for taking my questions. Just your newer partners, the NFL, the Yankees, the AAA. It's a different, I guess, characteristic relative to some of your older traditional retail counterparts. So I'm wondering, given that they represent slightly different kind of associations -- is there different some characteristics with the usage of the credit cards or the credit relationship with the customers from those different channels? Yes. So there are -- some of those cards are top of wall of cards. And so if you think about it, right? So I think about AAA, it's a top all of cards. So you kind of make sure you have the right line for the right people. It's higher use. It's discretionary spend, it's non-discretionary spend. That's their product. So make sure that we have the right treatments for those co-brand cards, which may differ a little bit from the treatments you have for the private label card. But diversification for us is key, and we don't treat every card equally. We treat it based on the habits of those people and those products. Is the general line extension and utilization rate consistent with some of the other platforms or is there anything to point out there? It depends on the creditworthiness of the individual, right? So, that's how we look at it. We don't look at it on a portfolio basis. We look at it within the portfolio and the performance of the individual and their creditworthiness. Okay, that's helpful. Thank you. And then a follow-up. We've heard from some of the other card issuers that maybe there's a decline and the pressures ongoing pressures on deposit prices. Are you guys seeing that? Or is there any commentary just over the past few weeks and what you're seeing in the deposit market? Yes. So for us, deposits remain direct-to-consumer deposit remains a key funding component. The pressures are out there in terms of pricing, yes, it's competitive. And we've been helping to lead the way on that competition because for us, it's a great source of funds. We are variable priced and we have terrific loan yields that can absorb the increases in prime. And as prime goes up, if we want to pass that through our deposit pricing, we get it on topside revenue. So we're good. I guess, the question is as we go into this year, is it similar competition to the last few months or given that the new rate outlook might be changing, are you seeing mitigated -- not mitigated competition, but maybe less aggressive pressure on incremental rates. Thank you. Our final question of the day comes from Regi Smith of JPMorgan Chase. Regi, your line is open. Please go ahead. Thanks a lot. I know the call is going kind of late. I appreciate you taking the question. A little bit, I guess, on a different subject. A lot of focus has been on credit quality. I was curious -- I was hoping you guys could probably answer this. What proportion of your business today and whether that's spend or revenues, would you say is related to Bread? And that could be, you know, the buy now, pay later, it could be the Amex card. Let me actually expand beyond this. And not just Bread, but anything like modern, so a digital-first card. What I'm trying to get at or understand is it feels like there's probably a story within the story that may be getting missed. And so I was curious if you could share how large that business is and maybe how fast it's growing, because I would imagine that over time, that, that's going to be a bigger piece and an interesting piece of the story. Well, the cards business, right? Things take time to grow, right? So we've been with both those products a year or last or just about a year. So I could tell you that 40% of our new accounts are digital channels, right? So, and I expect that 40% to grow given our new capabilities, given the capability we're going to put in place. So we expect those digital channels to grow. And we do expect direct-to-consumer to grow. I think that American Express product, 2% cashback is a really good quality product out there. The virtual card was just introduced that will have some traction in 2023, 2024. So while it's not the biggest part of our portfolio today, it is a growing part of our portfolio. Got it. And if I could sneak 1 more in. Have you guys ever provided, I guess, a longer-term target for efficiency ratio. I know you talked about margin expansion. That's been a theme every year, you kind of mentioned that. But is there a long-term target that you're driving towards? We talk about it in terms of positive operating leverage for now. As we think about the future potentially. But right now, we talk about positive operating leverage, which also helps our efficiency ratio. We have some internal targets, but primarily, we're looking making sure that our expenses outpaced our revenue outpaces our expense growth. Thanks, Regi. Thank you all. I know we ran a bit over, but I think it's time well spent with you. I really appreciate the interest in Bread Financial. I look forward to talking to you all soon. Everybody, have a good day.
EarningCall_1445
Good afternoon and welcome to SeaChange's Fiscal Third Quarter 2023 Conference Call for the period ended October 31, 2022. My name is Shamali and I'll be your operator this afternoon. Joining us from the company is Chairman and Chief Executive Officer, Peter D. Aquino; President, Chris Klimmer; and Chief Financial Officer, Kathleen Mosher. After the market closed today, SeaChange issued its financial results for the fiscal third quarter in a press release, a copy of which is available in the Investors section of the company's website at www.seachange.com. Before we begin today's call, I would like everyone to please take note of the Safe Harbor paragraph that is included at the end of today's press release. This paragraph emphasizes the major uncertainties and risks inherent in the forward-looking statements that management will be making today. As indicated, forward-looking statements are based on management's current expectations and are subject to a number of risks and uncertainties that may cause actual results to differ materially from expectations. These risks and uncertainties are also outlined in the company's SEC filings, including its annual report on Form 10-K and quarterly reports on Form 10-Q. Any forward-looking statement should be considered in light of these factors. Additionally, this call contains certain non-GAAP financial measures as that term is defined by the SEC and Regulation G. Non-GAAP financial measures should not be considered in isolation from or a substitute for financial information presented in compliance with GAAP. Accordingly, SeaChange has provided a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures in the company's earnings release issued today. I would like to remind everyone that this call is being recorded and will be made available for replay via a link available in the Investor Relations section of SeaChange's website. Now, I’d like to turn the call over to SeaChange’s Chairman and Chief Executive Officer, Peter D. Aquino. Sir, please proceed. Thank you, operator. Good afternoon, everyone. This is Peter Aquino, Chairman and CEO of SeaChange International and welcome to our third quarter call. Our momentum to strengthen our software platform continues and we are now hitting on all cylinders. Revenue growth was very strong, up 16% year-over-year and 13% sequentially. Profitability and cash generation continues as we record another quarter of positive EBITDA and increased our cash balance to nearly $15 million with no debt in the balance sheet. And our new SaaS and fast channel software products are now taking hold and producing incremental growth revenues now reflected in this quarter. Our transition towards providing our customers with streaming services and software to support their smart TV operating systems such as the project we announced last quarter would VIDAA in Hisense is clearly the momentum that we could build on. All of this is now translating into improved financial performance for SeaChange resulting in double-digit revenue growth. We continue to leverage our embedded expertise in video and ad tech to power Over-the-Top services for all of our customers. Our rich history of supporting MSOs, telcos and content owners allows us to upsell many of our customers with IP-based services that ride increasingly advanced broadband networks, not only in the U.S., but around the globe. Streaming content over wireless or wireline is being powered by SeaChange in North and South America, Europe and EMEA. We are truly an international software company with the bulk of our 100-plus software engineers working out of our office in Warsaw, Poland and we're so very proud of our team there, as well as all of our employees around the world. Many of our customers in the hose of the video industry are depending on us to seamlessly enable their move to the streaming world, while we diligently support their large deployments of traditional VOD in that insertion. Our embedded core business produces great baseline of cash flow as we reinvest that same expert team into everything streaming for connected devices. This is our future. This quarter is a great example of the impact of our revenue composition shift towards growth products. For example, new stream VID sales to content owners and software development for VIDAA specifically, contributed towards our high value mix, accounting for over 70% of new sales this quarter. We are managing our go-to-market efforts to continue to sell growth products. SaaS and streaming software products are not only high value in terms of expected multiples for these revenues, but tend to be more recurring in nature as well, which is a great business model. In addition, SeaChange's progress and consistent revenue growth, while rightsizing our cost structure has been fueling better cash flow and this is exactly the profile that we've been striving for and we could do even better. Our effort to promote profitable organic growth continues to be job number one. Simultaneously, we continue to look for ways to be opportunistic to gain scale. We continue to explore strategic and transforming ideas, as well as commercial opportunities with players in our space. Market timing for M&A is very difficult for most at this time in this current environment but we will aim to be prepared when the opportunity to transact arises. The good news that SeaChange changed a strong liquidity profile and a relevant video platform to sell and support this allows us to execute our organic program without much disruption. And as most would agree, the best time to discuss strategic alternatives and maximize values when the company is in a position of strength, along with improved capital markets. In the meantime, we have a large TAM and tailwinds in our favor for what SeaChange delivers and we aim to capture as many opportunities as possible to keep SeaChange moving in the right direction. So with that, let me pass the call over to our President, Chris Klimmer to take a deeper dive into our operations. Chris? Thank you, Pete, and good afternoon, everyone. Thanks for joining us today. Q3 was yet another strong quarter for SeaChange, as we continue to grow our top line and transition our business to a more sustainable level of profitability, while delivering increased value to our new and existing customers. During Q3, we continued to execute on our strategic growth plan centered around three main pillars. First, renewing and strengthening our long-term relationships with our existing base of longstanding TV operator customers, which has resulted in multiple long-term support renewals and several system upgrade bookings. Second, increasing our recurring revenue baseline with high-margin SaaS-based deals, and third, creating a new and extended product portfolio and services that can help our customers to maximize their returns across all TV and streaming channels, while also increasing end-user stickiness and engagement. Since our last call in September and in line with our strategic growth plan, we have executed on numerous accomplishments, which I want to spend a couple of minutes highlighting. As we announced last week, SeaChange was selected by Fox Sports Mexico to power their next-generation streaming service with our comprehensive streaming enablement platform, StreamVid. We believe we won this deal as we have the best technology to support Fox Sports Mexico's three key business objectives, which include, maximizing content monetization with flexible subscription packages and targeted advertising, retaining existing and acquiring new customers with the highest quality of service on all major device platforms, as well as increasing user engagement by improving user experience and simplifying content discovery. For those of you are newer to our company, StreamVid is a cloud-based, Over-the-Top or OTT streaming enablement platform that provides content owners the ability to deliver unique, highly scalable and personalized streaming services and to handle rapid user growth. Our new partnership with Fox Sports Mexico serves as further validation of not only the growing need for a platform like StreamVid, but also of SeaChange's unique capabilities in the market. This agreement with Fox Sports Mexico is a Software-as-a-Service engagement where SeaChange will benefit from FOX's success in growing their viewership base and increasing their subscription and ad revenues. It therefore supports our strategy of growing higher margin and recurring revenues. Sticking with the topic of sports, we recently expanded our services agreement with Grupo TeleCable, the leading cable provider in Ecuador to help support the streaming of the FIFA World Cup event in Qatar. Our cloud architected technology has proven to enable Grupo TV cable to support large increases in concurrent subscriber load and combines with our ability to enable an engaging sports experience with our flexible user interface. Lastly, we have completed a major development phase for VIDAA, the leading provider of operating systems for connected TVs in an ongoing project to help them build out their own dedicated streaming and free ad-supported streaming TV or FaaS services. As a result of completing this major phase, VIDAA can now launch the SeaChange-based streaming service on the millions of VIDAA powered connected TVs across the world, providing a premium experience for connected TV viewers and outstanding monetization options with SeaChange's ad insertion service for targeted ad insertions across FaaS channels. We expect VIDAA use of the SeaChange-based streaming service to be launched no later than Q1 with a potential impact to revenue as soon as Q4. Now looking ahead at the outlook and future growth opportunities for SeaChange. I'd like to point out two major organic growth catalysts we are focused on. The first catalyst is growth in the connected TV markets. As we've seen in recent trends, consumer eyeballs continue to shift towards streaming on connected devices and especially to the large screen. In this paradigm shift, there is growing demand for technology vendors like SeaChange that can help content owners realize their connected strategies and optimize their monetization opportunities. We believe our longstanding relationship with many Tier-1 operators as well as our growing international footprint with content owners, including positive reference cases make us an ideal partner for many of these players. The second catalyst in mass advertising. In addition to the consumer shift towards streaming of connected TVs, we've also seen a trend in consumers shifting away from subscription-based business models to free ad-supported content. We believe that with our unique technology to help operators and content owners alike to protect existing and build incremental ad revenue streams, we are extremely well positioned to grow our market share in this growth sector of our industry. By extending our product and service portfolio for existing customer base and by winning new logos that adopt ad-based business models, we can begin to increase our market share and capitalize on this new growth sector, driven by changes in consumer preferences. That concludes my prepared remarks. I'll now turn the call over to our CFO, Kathy Mosher to cover the financials. Kathy? Thanks, Chris, and good afternoon, everyone. Turning to our financial results for the third quarter of fiscal 2023, compared to the second quarter of fiscal 2023. Total revenue for fiscal Q3 2023 increased 13% to $8.3 million from $7.3 million in the prior quarter, driven by increases in service revenue. Product revenue for fiscal Q3 2023 decreased 27% to $2.2 million or 26% of total revenue, compared to $3 million or 41% of total revenue in the prior quarter. The decrease in product revenue was primarily due to decrease in licenses revenue. Service revenue for fiscal Q3 2023 increased 41% to $6.1 million or 74% of total revenue, compared to $4.3 million or 59% of total revenue in the prior quarter. The increase in service revenue was primarily due to an increase in professional services revenue driven by the acceptance of completed work by multiple customers. Revenue from our international markets in fiscal Q3 2023 was $3.6 million or 44% of total revenue, which compares to $4.6 million or 63% of total revenue in the prior quarter. Revenue in our U.S. market for fiscal Q3 2023 was $4.6 million or 56% of total revenue, which compares to $2.7 million or 37% of total revenue in the prior quarter. Looking at our margins, gross profit for fiscal Q3 2023 was $5.2 million or 62% of total revenue, compared to $4.8 million or 65% of total revenue in the prior quarter. Product gross margin for the fiscal third quarter of 2023 was 26%, compared to 72% from the prior quarter due to a significant increase in the amount of third-party goods for several customers that typically carry a lower margin and brought down the average product to margin. However, this was offset by strong service gross margins of 75%, compared to 60% from the prior quarter. Looking at our expenses, non-GAAP operating expenses for the fiscal third quarter of 2023 were $5 million, an increased from $4.8 million in the prior quarter. GAAP loss from operations for fiscal Q3 2023 totaled $3.7 million, compared to a $6.5 million loss in the prior quarter. Note, we recorded a noncash impairment loss on goodwill during the second and third quarters of $5.8 million and $3.3 million, respectively. Note that at quarter end, we no longer had any goodwill recorded on our balance sheet. As a percentage of total revenue, GAAP loss from operations for the third quarter of fiscal 2023 was negative 44%, which compares to negative 89% in the prior quarter. Non-GAAP income from operations for fiscal Q3 2023 totaled $152,000 or breakeven per fully diluted share, an improvement compared to $11,000 or breakeven per fully diluted share in the prior quarter and our second consecutive quarter of positive non-GAAP income. As a percentage of total revenue, non-GAAP income from operations was 2%, compared to less than 1% in the prior quarter. GAAP net loss for fiscal Q3 2023 totaled $3.7 million or a loss of $0.07 per basic share. This was an improvement compared to a net loss of $6.5 million or a loss of $0.13 per basic share in the prior quarter. Non-GAAP net income for fiscal Q3 2023 totaled $134,000 or breakeven per fully diluted share, compared to a non-GAAP net income of $52,000 or breakeven per fully diluted share in the prior quarter. Turning to our balance sheet. At quarter end, we had $14.5 million in cash and cash equivalents, which is an improvement, compared to $14.3 million at the end of the prior quarter. We continue to have no debt on our balance sheet. This completes my financial summary. For a more detailed analysis of our financial results, please refer to today's earnings release, as well as our 10-Q, which we plan to file by the end of the week. I will now turn the call over to Jeff Grampp from Gateway Investor Relations to moderate the question-and-answer session for presubmitted questions. Thank you, Kathy. This is Jeff Grampp of Gateway Group SeaChange's Investor Relations advisors. I will now read out the top questions that we received at our firm from investors ahead of this call. The first question is with the stock price at this level for an extended period of time, much like many micro caps, what actions has the company taken with respect to NASDAQ? Thanks, Jeff. First of all, I believe that the share price of the company doesn't really reflect the assets or the strong financial and operating results that we discuss here today. And I am a real believer and I've been a buyer of the stock personally in the open market this year as I believe SeaChange is an attractive investment. But specific to the NASDAQ listing, we filed an application on December 6 to be listed on NASDAQ's Capital Markets tier that better matches our peer group and this will have no practical effect on the trading of our stock. However, this will provide the company with a six month extension to get our stock price up through execution despite broader market conditions to meet NASDAQ lister requirements. This is exactly what a lot of micro caps are doing today as we speak. So as time progresses, we'll provide regular updates as necessary to keep everybody informed. . Thank you, Pete. The next question is for Chris, which products or services do you expect to be the most meaningful revenue contributors for SeaChange looking ahead, understanding that the sales process can be somewhat lumpy? Thank you for this question. So, first I think that the performance over the past five or six quarters, where we have posted steady quarter-over-quarter top line growth, shows that we have been successful across all our key revenue streams, products and services alike and that we have diversified our revenue structure. This is true for our core operator business and our services business all the way to our new product lines that generate SaaS revenues for us. In terms of these products that we are very excited about here at SeaChange, I would start with StreamVid, our comprehensive streaming enablement platform that offers a multitude of options to attract viewers and monetize content. Another exciting market for us is free ad-supported streaming TV or FaaS where we can support operators, content owners and TV platform providers to provide streaming services and monetization capabilities through ad insertion. Lastly, we should not forget about our ability to expand and deliver for our longstanding relationships with Tier-1 telcos. This market still delivers strong revenues and margins for us. Essential for us to build value and drive innovation across all of our product lines is our center of engineering excellence in Poland. You may remember that we have more than 100 full-time in-house video software engineers that help us to realize innovation along our tech roadmap and to accelerate the expansion of our product portfolio. For example, we have just recently filed two provisional patent applications for products that will enable our customers to further personalize the viewing experience on their platforms and to measure and stimulate engagements. Thank you. Thank you, Chris. The last question we received is for Kathy. How should investors think about the company's ability to grow revenue and achieve positive EBITDA? Thanks, Jeff. We have been encouraged with our operational performance that has generated strong top line revenue growth, while our costs have remained relatively stable and more efficient during this timeframe, allowing us to generate positive EBITDA for two consecutive quarters. Further, we've been encouraged with our results year-to-date with revenue of $22.3 million, up 19% over the prior year period, while non-GAAP operating costs of $14.5 million has decreased 10% over the prior year period. We remain optimistic about our future revenue growth capabilities and do not expect our cost profile to change materially over the near and medium term and therefore feel good about our ability for an EBITDA breakeven or better outlook. Thank you, Kathy. This completes the pre-submitted Q&A session. I will now turn the call to the operator to continue the Q&A session for today's listeners. [Operator Instructions] And our first question comes from the line of Nehal Chokshi with Northland Capital. Please proceed with your question. Yes. Congratulations on the solid results, sequential increase and free cash flow generation there. And the FOX Sports Mexico is a strong testament to the tantalizing opportunity that you talked about of subscription content moving towards advertising. Can you discuss the evolution of that deal? And the potential for that deal to replicate across other properties of Fox, as well? Thank you, Neal. Let me take this question. So essentially, the evolution of the deal is based on a very strong sales effort in the region. You may know that we have sales teams locally also in Latin America and the focus here, especially with selling the streaming platform and the services that the platform entail is to help content owners that have a premium content proposition to reach their subscribers directly to go direct to consumers with the full flexibility across all of the monetization models that are possible in streaming. Fox is a good example - Fox Sports Mexico is a good example that shows how our platform allows high-tech monetization model. They will go to market both in the subscription model, but also use our ad insertion capability. And I think it's a testament not only of our ability to be the great technology vendor to premium and Tier-1 media and content companies, but also to our ability to help that content to be monetized across business models, across platforms and eventually, hopefully also across territories. I think we have a very, very good global sales team. Latin America has shown very, very good results over the past couple of quarters. We believe that the market in Latin America is in a perfect state where more direct-to-consumer content propositions push to the market and with the good reference stations that we have there now with a good footprint with a strong sales team and of course, is our product, I think we're in a very good position that we need to be successful in this market. So we do see some push in other markets as well. I just want to highlight the VIDAA engagement within revenue. So, VIDAA is also a global company, but the main operations in Europe and EMEA to be precise. So we have a very strong footprint across our main markets, which are Latin America and North America and EMEA. To replicate this particular engagement in Mexico to maybe on the sports bodies or sports [Indiscernible] it's something that we're actively working on right now and we hope to show first results in the sports sector over the next quarter or two. Thank you. At this time, this concludes our question-and-answer session. If your question was not taken, please contact SeaChange's IR team at seac@gatewayir.com. I would now like to turn the call back over to Mr. Aquino for his closing remarks. Thank you, operator. Well, we appreciate your interest in SeaChange and look forward to our future communications. Have a great evening, everyone. Thank you.
EarningCall_1446
[Call Starts Abruptly] -- in Europe. And the Board took upon itself to refresh itself also. So, they have initiated a process, in October, of 2021. And for now, we basically have 75% of new board members. So, you see on the list here all the new board members who were added to the list who, again with the same concept, are coming with the skill set that is required, needed, necessary for the future of the company, which is international commercial expertise, they know what it is to negotiate with Australia, with many of these markets, but also at a European level where we're working very hard to ensure that we are successful there. Now, if I move on to the third part of my presentation, which is really the next chapter, so what are we set out to do for the next phase. Our priorities and our goals are very clear; we have to continue to geographical expansion. This is the key to shareholder creation, right? We know that the U.S. is the U.S. We have generics; they're not going to be less, they are going to be the same or more. And we can hold on to the revenue for as long as we can, but let's face it, we're going to see price erosion, we're going to see additional pressure. So, we have to continue to make progress quarter-after-quarter at the European level. So, that's with the geographic expansion, and of course, beyond that, to the international markets. The second part that we have to focus on and we should not stop at VASCEPA. There is huge value of bringing VASCEPA with rosuvastatin and atorvastatin, because that gets you to gain years in adoption, right? If you put a very familiar molecule with a still new molecule, you just gain, and we're going to talk about that again in a few seconds. And finally, we have to do those two while we continue to be very disciplined in terms of financial management and our operating expenses. So, on Europe, we have steps one, two, three of pricing reimbursement in all of our countries completed. We are only focusing really now on pricing reimbursement negotiations in the remaining markets. And we believe we're going to get the vast majority of these, getting price reimbursement in 2023. Beyond Europe, we need to continue the international journey, we have six approved, but we need to get to the 14 remaining by the end of 2024. And we have to do this while we continue the focus on operational excellence. So, in terms of operational excellence, priority number one is profitability in the U.S. As you know, we have adapted our plans as we went along; we actually have cumulative revenue of $1 billion in the U.S. since generic introduction. If we had pulled just immediately I don't know if we would have had this revenue by now, right? So, we continue to look and anticipate what's going to happen in the market. If we see a hit, we will react, right? Very are very clear that if we see an additional fit from Teva, who listed but is not on the market yet, if we see an additional threat we will be the first to act to preserve the profitability because we need that cash to launch in Europe, and we're very conscious of it. So, that's first area of focus. The second one is maintaining financial discipline just across the line, right? And I can tell you, big part of this is the sequenced investment in Europe. If you look at how we are working our investment base at European level, we do not hire commercial headcount unless we see somebody holding the pen and signing a reimbursement in a country. So, today in the U.K., we are building a full team that is fit for purpose, right, meaning sized appropriately to what is needed. We have not inherited a feel for size from a prior launch, and we have to have people that we don't really need, we only hire what we need with the expertise that we need. And all of them are coming with the business acumen and the expertise in cardiometabolic that is required for the job. And we will continue to do that. One might say, but why don't you find the way of just throwing everything at it and maybe you're going to get a lot more out of that? The realty is the market has changed dramatically, even before COVID. Today, we are not in the market where you are in carpet-bombing and just throwing everything at a launch. You need to know what you need to do. And I can tell you, for this product it's about scientific engagement, okay. If physicians are convinced of the value they will prescribe. Going there and repeating a message every day without people believing the evidence is not of value, right? So, that's what we are doing, we are putting the right investments, and will sequence them appropriately so that we do not waste resources without real value early on in the launch phases. Now, moving on to the next chapter in terms of diversification, we actually have three key areas where we have true strengths. So, we have a commercial team in the U.S. that's holding on to 60% market share despite three to four generics, and they are a very, very capable team. Most of them have been with the company for the last eight to 10 years, so very significant experience in the field. And at the same time, we are building a world-class team in Europe that is delivering on the pricing reimbursement that you've seen that is launching in the U.K. and in other markets in a capable way, so very strong commercial capability, but we also have the R&D engine that we have preserved because we believe that this is of real value, and that expertise, there need to be preserved. And now we are building that very significant medical affair team that has the cardiovascular network. So, that allows us to do beyond VASCEPA, but at the same time, we want to say that the first thing we want to focus on is actually our own fixed-dose combination because we believe that this could be a very significant opportunity in the marketplace, right? And again, I have personal experience with launching multiple portfolios with line extensions. I can tell you it makes a very, very big difference, especially if you are a new paradigm. And in our case, there is not a clearer new paradigm than us; we're the first non-LDL asset that demonstrated cardiovascular outcome on top of a statin, we're the first, right? And remember, there were so many failures before us. You know, I see ETP inhibitors try to demonstrate that and failed on top of a statin. Other molecules tried to demonstrate that and failed; we are the first, but we are launching in Europe with pre-marketing, right? With no initial market development, we wish we had that luxury, but what situation we are inheriting just -- we didn't have that. We had to do Europe because of the challenge in the U.S. So, to do that, right, associating yourself with some of these molecules can be very important. We already initiated a process to seek guidance from EMEA on the regulatory pathway. And we are hopeful that we'll be able to share more details with our investors in the next quarters, but this is a very, very significant step in our diversification. So, to try to close on our priorities, 2023, look, our work is carved out for us very clearly. We have to continue to make progress on the reimbursements. This is probably the number one priority to create incremental additional shareholder value for the company, is more reimbursement in more countries in 2023, and doing that while maintaining profitability in the U.S. We already communicated that we believe we are sufficiently funded to launch in Europe, but big part of that is maintaining that profitability. And as we said, we are ready for whatever scenario that can come our way to ensure that we continue to deliver that contribution margin and that U.S. profitability that is needed for the launch. We will, and we will continue to work on obtaining additional international regulatory approval, very critical. We do not plan to do this ourselves. Hopefully, 2023 is going to be a year where we can communicate some of the partnerships that we will have in many of these markets that will still allow us flexibility for the future of the company, which is very important for us. So, it's not about just partnering, it's making sure that we maintain the flexibility, and at the same time advance the fixed-dose combination which we believe will have a significant impact on the lifecycle of the product, while exploring, obviously, other VD opportunity. Finally, do all of that with a very, very, very strong focus on financial discipline, and making sure we do more with less. I just want to finish by saying, look, we have a bold ambition. Our bold ambition, and the reason why we all joined Amarin in the last two years is the following. Many of us launched cardiometabolic molecules across the world. Our experience says that you can have a 50-50 split between U.S. and ex-U.S. business, right? Lipitor had that, at least [indiscernible] franchise that I know very well had that 50-50 split between U.S.-ex-U.S. Well, if you look at the potential of VASCEPA is the U.S., the lowest estimates were that this product was going to sell $3 billion in the U.S. So, if we say that the European opportunity is a billion plus and the international market is maybe close to a billion, then we are not far off from that assumption. We are here because we believe we can recreate this potential. And the path to that is to get pricing reimbursement in Europe, launch successfully in Europe, expand to international. And, we to continue to maintain the profitability in the U.S. to ensure we are going to be self-funded for that. So, I want to thank you all for your attention. I know it's a long day, but pleasure to be here in person with you all in San Francisco, and thank you. Can I ask a question about the material because I saw a report from the Dr. Reddy's? They said, okay, maybe in the next few years we got maybe several generic drug trials to come, and in a few years, maybe the raw material, I mean the EPA -- the raw material, the price could be up like they will sell it over 50%. That influences a lot. So, what do you think about that? Look, so first of all, I am not a manufacturing expert, so I will not be -- claim for that, but look, you know the manufacturing of this product is very, very complex. If it was not, okay, you would have seen very different volumes on the market. A rate limiting step is the cost of the raw material, but let me tell you, that's not the only rate limiting step. The other limiting step is the technology that is needed to transform the raw material into 96% pure EPA. And for that, there are multiple technologies on the market. Some of them have very different yield from one another, right. So, some of them can turn this much raw this much pure, or you need to have three times more. So, this is not as simple as it sounds. Having said that, look, if the cost of goods is going to cheaper, which is going to get the product to be at a lower base, we are going to benefit from that probably more than anyone because we believe we have the best set-up in terms of supply chain at this point in time. So, I don't know if this is going to be a competitive advantage to the generics. And on top of that, remember that Europe has regulatory exclusivity until 2031. And we have plans to extend that in many ways. So, we are not going to face any generic challenges in Europe or in the international market. So, this may be valid where we are in the U.S. Let's face it. If this is coming in 2025, we would be way ahead from where we need to be in terms of driving E.U. business, but good question, thank you. Maybe I'll ask a question in relation to that. You're currently undergoing renegotiations for supplier agreements. So, can you maybe comment on that? And what does the process involve for that renegotiation? Sure. So, we have not disclosed many of the details obviously on these renegotiations, because their nature is obviously very confidential. All what we communicated before was basically this is a product where you have dedicated manufacturing facilities, right. This is not a simple solid form manufacturing facility where they can produce 10 different products. They only work to produce 96% EPA. So, the way they operate, they have to dedicate their effort to you. And for them to do so, you have to commit for a long-term arrangement, usually three to five years at least. And you have to commit to volumes that you are going to purchase at least for 18 months. So, to get in or to get out of this working relationship is not a simple procedure. The real value that we have with our partners from a supply perspective is that they see us building a market in Europe, right. This is the big advantage that we have is that they see us opening country after country after country. They see us continue to pursue Asia. They see us working to get the China approval, right. So, they understand that if there is any future volume that's going to come, let's face it. Amarin will continue to be the key customer for those suppliers. They want to work with us, and they understand what happened in the U.S. What happened in the U.S. was out of our control, right. That was an IP situation. We lost volume. We had to act on it. So, they are understanding, they are collaborative in most cases to try to see how we can arrive to an arrangement where we can continue to work together, but that's really what we disclosed up to now. And we will continue to work on that. Look, supply chain is an important advantage in this business, and consistency and quality of supply is a critical priority in the business. Maybe focusing on the o-U.S. launch with VASCEPA, with national reimbursements now secured in five countries, how would you characterize the size of the collective market in this regions and the potential revenue in 2023? Sure. So, we currently have national reimbursement in the U.K., Sweden, and Finland. We have individual reimbursement in Austria and Denmark. Individual reimbursement actually means something similar maybe to prior authorization in the U.S. which means the physician will have to get an approval from the authority to get the product reimbursed. It's an electronic procedure where they have to take. And you start with that in many countries until you get national reimbursement. Now, if you look at the size of these markets, the U.K. is obviously the largest. If you look at the E.U. business split by country, between the four to five large markets, you cover 50% to 60% of the business. And then, the remaining markets are really 40%. So, today we have the U.K. The U.K. will be a significant contributor of revenue in 2023. We believe we are going to have other larger markets where we are going to get pricing reimbursement in 2023 that they are not on the list. We are working to get them first, second, third quarter as we go along. And together, they are going to be really the big contribution for the business, but overall if you add these up, they would be maybe 20%, 25% of what the business is. Do you expect to have more physical versus digital presence in Europe? And with that in mind, how much larger should we expect your sales force to grow in that region as you gain reimbursements in 2023? So this is one of the benefits we have of building the business bottom up which is to say what is really necessary for us. We know today that in the U.K. by law, you can only visit the physician twice a year in an unsolicited visit. Meaning you just cannot do that by law unless they invite you, it's a different story, but uninvited, you can only see them twice. So, if you are in a launch mode and you don't have a digital capability, it's going to take you a very long time to get to the exposure level that you get physicians to truly prescribe. So, the way we built our model is that we are digitally native. Digitally native means we actually start with digital. We start with digital. We start the awareness with digital. And when it's time to bring the headcount, we bring the headcount. Because let's face it, digital costs a lot less. You can optimize the value. Meaning you can take something that develop for the U.K. and use it in Sweden. Use it in other markets where you cannot do that with a rep. So, there are so many advantages of going digital compared to going face-to-face. And we are using all of that as we are working through our launches in the markets. Continue. Given what has happened in Germany last year, can you maybe outline for us the path and timeline towards pricing and reimbursement in Germany for VESCEPA? And what that would involve? Sure. So, the price and negotiation with Germany arrived to a point where we just agreed to disagree somehow. I mean the price point that they were proposing was just lower than our cost of goods, as simple as that. So, it was not something that we could entertain. Unfortunately, it's not uncommon in Germany that this is happening because just as a reminder, Lipitor from Pfizer did withdraw because of a price challenge at the time of simvastatin going generic. Crestor never launched in Germany. Many other valuable molecule had to withdraw out of Germany because of the way the process is structured. Having said that, there were factual mistakes that happened in the evaluation, in the scientific evaluation of the product in Germany. So, we do intend to explore every legal avenue to challenge the GKV decision. So, we are a company that does not give up easily. I think we've shown that from the first two chapters of the company and how we just don't let go. So, because we've seen that the treatment of the dossier was not as you would expect, right? So we plan to challenge that. But at the same time, we found at least one precedent where there was a rejection, and the company came back with different data, like real-world evidence to demonstrate the value, and it succeeded. So, because we have this precedent we plan to pursue a similar approach. And we still believe that German patients are worth us continuing to try, right? And we have German scientific leaderships who are very big believers in the product. So, we will continue to make the effort. And by the way, a pricing reimbursement in the U.K. helps, pricing reimbursement in the Nordics countries helps because the Germans still look around them and see what is going on, what are other governments paying. And as a reminder, our price in the U.K. is net visible to everybody. So, unlike many of the recent launches, we do not have confidential discounts. Recent PCSK9 launches have discounts up to 90% of the list price. Most of the cardiometabolic launches have these confidential discounts that range from 20% to 40%. The price you see in the U.K. is the price what the U.K. government pays, EUR5.-something a day. So, this is visible to Germany, this is visible to France. This is part of our strategy to say, "Look, we don't have time to play games, we're not here to try to play smart and just get the maximum out of you. This is the value of this product. This is how much we save in MIs, this is how much we save in hospitalization. This is how much we save in stroke." And that's why you see the Nordic U.K. markets very successful in pricing reimbursement because these guys go by the book, right? They look at the models, they look at the value and they say, "Yes, I cannot push you back, it's true you are saving me money. Yes, I'm going to pay." Now, there are markets where other parameters are involved, so your budget impacts, other situations. So, Southern Europe gets to be more nuanced, so we have to do additional efforts in many of these markets, but we are doing them one by one. I'll take the example of France. France is a country where you have to demonstrate that you're creating value for local economy. We have a supplier in France. We have an encapsulator in France. So beyond our business and going, establishing ourselves in France, we are fueling French economy. And we are using this argument with the Ministry of Health to say, "Look, this is not just about helping the patients, we are also helping the economy at the same time, indirectly, via our supply chain." So, that's some of the efforts that we are doing in U.K. or beyond. So, keeping that all in mind, can you walk us through your projection of $1 billion-plus peak opportunity without Germany? And what would that peak opportunity increase if you actually include Germany? Yes. So, first of all, you know we haven't given the guidance on European numbers of the split of $1.5 billion. But you're talking about a product that is priced today at EUR5.00 a day. If you look at all the other cardiometabolic products that have launched, overall, you're talking about the range of EUR1.5 a day to EUR2.5-EUR2.8, right? So, we have a price advantage that will allow us to bridge any gap in penetration. If I just compare myself to a product that I launched myself a number of years ago, but the [indiscernible] franchise, the product was sold at EUR1.5 a day and it peaked at EUR1.4. It peaked at EUR1.4 with a third of the price of -- was used on top of a statin. So, very similar patient population, and it had a negative enhanced student that impacted. So, I'm not trying to say, "Use that as a benchmark, that's exactly what we're doing." I'm just trying to give examples of the eligible population and what you can deliver and demonstrate. Now, Germany or any large market, as we said before, is going to be somewhere between 10% to 15% of the overall. So, if we go back to Germany, you should expect a 10% to 15% on top of that number. But for the moment, we stay to about $1 billion in terms of revenue for Europe. And if Germany comes our way, and let's face it, this is going to be a tough one to crack, where we don't want to in any way say that this is going to be easy; this is going to be a very challenging one, but we will continue to work on it. And maybe moving to the U.S. side, how are you thinking about the potential gross margin for VASCEPA in 2023? And do you -- should we expect it to be similar to 2022? Sure, thanks, Sammy, for the question. So, we haven't given forward-looking guidance related to revenue in 2023. So, obviously, without doing that we don't have the gross margin. What we have stated is that we do expect to see some price decrease in the top line, so it would impact the margins, but not substantially. Just quickly, going back out of -- back off the U.S., you've recently announced the approval of VASCEPA in Australia. How large is that market opportunity relative to the U.S. and EU? So, if you look at the products that made it to Australia, Australia tends to be a very challenging market from a pricing reimbursement perspective, just as tough as the U.K. and some of the European. They would be, in terms of size, immediately after the big five in Europe, right? So, usually, when you have a successful franchise, and I had many of these, you would have Australia in your top 10 markets, right? So, you have U.S., and you have the big five, and you have Australia there; some molecules delivered $200 million and $250 million of revenue in Australia and New Zealand. But you need to get pricing reimbursement appropriate with the right price level with no caps. They're very, very famous for capping the products, that's another one that you have to deal with. The potential is definitely there. They're very tough. We have a very good label, and we have scientific support in Australia. And we're starting the journey now that we have the regulatory approval. Maybe can you give a little -- give us a little color on the fixed-dose combination as a lifecycle management for VAZKEPA? And I believe you're only doing it for VAZKEPA, not for VASCEPA? Yes, so we are obviously prioritizing the work for Europe for very obvious reasons, right? We are protected in Europe for the next 10 years. So, bringing a fixed-dose combination for Europe makes a lot of sense because you're really protecting the value. But also remember, many of these markets, after three to five years of being on the market, they usually want to re-evaluate your price, right, and basically bring you down. One of the ways of giving them a true value at that point in time is to say, "Look, I'm willing to give you a fixed-dose combination, it has a statin, okay? And I'm going to give you the statin for free. So, instead of you impacting my price everywhere, I'm going to offer that, and you keep the price of your main molecule, and you keep going." So, this is one of the strategies that key portfolios apply to ensure they keep the price because, remember, in Europe, prices only go down, they don't go up. That's why if you put all your effort to be at this highest possible point this is where you start, right? So, the highest you can get there, within logic. Don't get me wrong, it has to be documented, you have to demonstrate the value, then the better it's going to be. In terms of, as I said, the adoption, it's of real value, right? How long will it take you to get the familiarity of VAZKEPA to be similar to Crestor or Lipitor? It's going to take time. You put them together; you saved two years of adoption. So, that's a big part of the plan. And we believe it may have also impact on the protection, but we will talk to this -- about this at the right time.
EarningCall_1447
Good day and thank you for standing by. Welcome to the Bank OZK Fourth Quarter 2022 Earnings Conference Call. [Operator Instructions] Please be advised that today’s conference is being recorded. Good morning. I am Jay Staley, Director of Investor Relations and Corporate Development for Bank OZK. Thank you for joining our call this morning and participating in our question-and-answer session. In today’s Q&A session, we may make forward-looking statements about our expectations, estimates and outlook for the future. Please refer to our earnings release, management comments and other public filings for more information on the various factors and risks that may cause actual results or outcomes to vary from those projected in or implied by such forward-looking statements. Joining me on the call to take your questions are George Gleason, Chairman and CEO; Brandon Hamlin, President; Tim Hicks, Chief Financial Officer; and Cindy Wolfe, Chief Operating Officer. We will now open up the line for your questions. Hey, good morning, guys. Congratulations on a great quarter. First of all, I guess when you all are thinking about originations, I mean, I think it was 2.81%, it’s still extremely high relative to what we saw in ‘21 or early ‘22. What’s the reason maybe for the thinking it will be a little slower? Is it just overall economic slowdown? Are you seeing more construction projects kind of get tabled today than you were maybe 90 days ago or how can we think about those trends that you are seeing from customers in that space? Absolutely, Steve, and great to hear from you this morning. Yes, we actually, last quarter, we had the same question and the answer is similar. You hit on a couple of the items that are impacting deal flow, costs have continued to increase, although I would say that we are hearing and seeing anecdotal evidence that the velocity of those cost increases is coming in. So, it’s still up but at a slower pace. But obviously, interest rates have not slowed down. So, that piece of the puzzle still pressing against new deals, but we are still seeing new deals. We are still signing up new opportunities. And – but given that the pie is a bit smaller, we will probably take a little bit less in 2023. I mean, competition is really not a piece of that answer. We have had really good success in pushing into and getting our fair share or more given where the competition is. And as I have said in the past, the quality of what we are able to originate today in light of less competition is lower leverage and better spreads on the deals that we are quoting and winning. Okay, great. And this question may be a little early, but I think it starts to become interesting. If rates begin to rollover in the back half of the year, how do your floors play into that? Yes, Stephen, let me tell you that. Obviously, the longer the Fed stays at whatever their terminal rate is, the better that works for our floors, because loans that we originated 2 years ago out of floor near the origination rate on those loans, we are obviously way away from those floors before they would become active. The loans we originated last quarter maybe at or very near their floor rate. So, the longer the Fed stays at whatever the peak rate is, the more we roll off older loans that are far from the floor and replace those with new loans that are at or near the floor at the time of origination. So the scenario where the Fed slows their rate increases and maybe has 1, 2 or 3 more quarter point increases and then stays at that rate for a year or longer, the longer they stay there, the better it is for our floors and the more defensive it is for our margin. Yes, that’s helpful. I mean like at a very high level, is it fair to just kind of think about the – and I understand what you are saying, George, is this – these numbers are improving every quarter, but almost the inverse of the charts you were showing previously as rates went higher and just how the percentage of loans that would fall into protection from those floors? Is that kind of roughly how we could think about it? Yes, exactly. And if you think back a year or two, we had a lot of loans at the floor rate was way above what the formula rate was at the time and rates had to rise 50 or 100 or 150 or 200 basis points before we got above those floors and those loans activated. The Fed kept that from being a big issue by raising rates a lot in big chunks and quickly in big chunks. So we quickly got over those floors, and you can see the benefit of that in our record levels of net interest margin and core spread that we have been achieving. So yes, the flipside of that is true. And Stephen, that’s why we have made the comment that we will when the Fed stops raising rates and deposit costs catch up, we will see a reversal of some of this significant improvement in net interest margin and core spread that we have had over the past year. It’s possible that Q4 was the peak in our net interest margin and core spread. It’s likewise possible that we could have another quarter where we have some improvement in NIM and core spread. But based on the fact that the Fed is going, it seems like the 0.25 point increases and the number of those as a legitimate question, is it 1? Is it 2? Is it 3? Is it 4? But those quarter point increases, we are going to see a catch-up in our deposit costs. So we are - if we didn’t hit peak NIM and core spread in Q4 would probably would eke out some small incremental gain in Q1, I can’t even - I hope we will have a gain in Q1, but that’s questionable. But at a slower rate of Fed increases with deposit costs, which lagged beginning to catch up, we will see some erosion of those recent gains probably in Q2 at least. Yes. Well, the NIM peaks at 5.50 range, you are going to be doing better than 99% of banks anyway. So we are fine with that. I guess the one follow-up is just when you think about that deposit lag in the back half of the year, how do we try to frame that up at all, because that, to me, is the hardest thing to try to anticipate. We can think about betas when rates are rising, but when they are not, how do you think about that kind of lagged pressure in the back half of the year on deposit costs? Well, our – the way we are thinking about it is doing everything we can do to roll floors up and make sure that the deposits that we put on are not too long a duration. Now we added some duration to the deposit base last year, because and you saw that with an increase in the volume of CDs. That was intentional to put some duration in that book knowing that we were going to have strong loan growth in 2023 and probably weren’t going to see rates coming down much at least in the front half of ‘23 and maybe not at all in 2023. So – but we are beginning to shorten the duration on new CDs we are adding and still doing a bid out longer, but we are pulling some of those and in some categories the deposits just to get ready to have deposits repricing late ‘23 and early ‘24 as we think that’s probably the likely timing that the Fed might be in a cutting mode if they are. Thank you, Stephen. Well, I want to give a shout out to our Cindy Wolfe and Ottie Kerley, our Chief Deposit Officer; and Drew Harper, who manages our wholesale funding. That deposit team and all the guys that worked for Ottie and Drew and Cindy there, have done a really good job of making adjustments to what we thought our interest rate risk profile is. And we have had a really nice expansion in our net interest margin, core spread, net interest income and that just didn’t happen. They have been very strategic in the way they have managed that on the liability side as our asset guys have and the team deserves a lot of credit for how well they have managed that. Thank you, Stephen. Thank you. [Operator Instructions] Our next question comes from the line of Manan Gosalia of Morgan Stanley. Your line is open. Good morning. So I just wanted to follow-up quickly on the last line of questioning. So I guess with the new CDs that you are putting on and the fact that you are reducing the term of those CDs, should a large chunk of the CDs come due for repricing towards the mid to end of 2023? Did I hear you right there? Manan, I would say that they are more laddered out throughout ‘23 and into early ‘24. So it’s a pretty well-managed ladder. We have got CDs maturing everyday and we have kept a considerable focus on keeping that distributed fairly even so we can just manage that effectively instead of having big chunky pieces of it maturing here and there. So it’s very well diversified on a day-to-day basis throughout ‘23 and into ‘24. Got it. Perfect. And then maybe just a big picture question on repayments just given that the refi market takes out a larger portion of your loans. I guess just based on your conversations and given how close we are to peak Fed rates, how quickly do you think that the capital markets can open up and push sponsors to move to more permanent financing? And maybe you can just add and based on what – how you have seen this play out before I guess, what’s the best estimate in terms of how high repayments can go this year? Well, again, we have said that we think our RESG repayments will be in the range that we achieved during 2021 and 2022. So that’s $6.22 billion to $5.65 billion is the likely number there. It could be a little more than that. It could be a little less than that. But we are thinking that, that is the range for repayments next year. And I would tell you that the capital markets are not closed. Transactions are getting done. Sponsors were just not as excited about the rates they are getting as they would have been on rates a year ago. One phenomenon that we have seen and I want Brandon to comment on this, but one phenomenon that we have seen in the past, Manan, in response to your question is, if sponsors tend to think that they are going to get a much better exit 6 months or 12 months down the road than they are today, a lot of times, they will stay in our more expensive construction loan a little longer if they think they are going to exit today at a 7% long-term rate and they think it can get a 6%, if they wait now more months, they will tend to stay in our loan a little longer to get that better exit. Sometimes they do that, sometimes they are just ready to put the permanent bed and go on down the road. But Brandon, do you want to comment on refinance activity next year or this year in ‘23? Sure. No, you characterized it correctly, George. I think one of the – we will likely have a number of those short-term extensions, 6, 9, 12 months just as you said. And really, there is so much we don’t know about exactly where longer term rates are going to go. As George said, the market is still open. But as those rates move back to a more normal place, we would expect the repayments to accelerate. I think back half of the year is likely to be higher than the front half of the year. But as we know and there is to our benefit certainly from an average earning assets point of view and when we make those loan extensions a lot of times, we will obviously get more, little more fee income, perhaps little more minimum interest and but they are not long-term in nature. And so when the capital markets come back, they will move on. Our rates are not as attractive, obviously, as the long-term rates. Yes. And I would emphasize Brandon’s point that we are – we view loans staying on the book 6 months longer, 12 months longer is a very positive thing. It greatly improves our return on equity on those loans to have them sit on the books longer. Right. So I think that was going to be my follow-up. So I mean, if it stays on the books for longer, you have higher earning assets that helps your NII even if NIM is declining. But as you run your scenarios on the different macro assumptions, is there – are there any situations in which NII peaks and starts to decline or should we just continue to see this NII ramp up and get to peak NIMs in the next couple of quarters and then move down from there? Well, that’s a good question, Manan. I would tell you that our prevailing thought is, is that we will see some compression in NIM and core spread in the coming quarters, but that that’s going to be more than offset by growth in average earning assets. We alluded to this in our management comments specifically and I have referred to it internally as a baton handoff where that growth in net interest income is ceases to be driven by NIM that actually becomes a little headwind, but we have got great originations that have occurred in 2022 that will drive loan growth in 2023 and 2024 and the continued increasing diversification of our portfolio should also help us drive loan growth in 2023 and 2024. So we are cautiously optimistic about a positive net interest income story. Thank you. [Operator Instructions] Our next question comes from the line of Timur Braziler from Wells Fargo. Your line is open. Just following up on that last line of commentary, how should we be thinking about balance sheet loan growth in 2023 given the expectation for slowing originations? Is that pretty much scheduled and you know what you are expecting from a funding standpoint or could that too slow? Hi, good morning. Tim here. Given the level of origination volume we’ve had over the last four to six quarters, that – given our construction loans and the fact that in many of these loans were funding later in the construction phase. We do kind of know the schedule to a great extent of the funding for those loans. And so that gives us confidence, and you saw on Page 5 that we said we thought for 2023 that loan growth – 2023 would meet or exceed the $2.47 billion we achieved in 2022. So – and a lot of that is just the delayed funding sequence we have in those RESG loans and in combination with the growth profile that we have from some of our other business lines like asset-based lending and our Community Bank. We’ve got pretty good visibility into that for the 2023 year. Okay. Great. And then maybe just a follow-up for you, Brendan. In looking at the national markets and kind of asset classes within RESG. Where are you seeing the most amount of resiliency right now? And then conversely, are there any geographies or asset classes that are seeing any kind of marked slowdown in either activity or valuation. Yes, yes. So what’s interesting, the book that we see coming to us continues to be a fairly diverse book, both geographically and from a property type perspective. I think one that stands out, and we’ve talked about it before, the upper Midwest, which includes Chicago, has been a little slower the past several quarters and then it continues to be the case. We’re still looking at deals there, but just on a relative basis to our history, a bit slower there. But when I look at what we’ve got signed up in the pipeline to close, it has a pretty similar mix as historically, you’re less office probably than we’ve seen, but we are still seeing office opportunities with pre-leasing frequently available in those opportunities. And as I said before, really great position to achieve the low leverage that is our standard and really improving on that. But the Southeast continues to be south, southeast, southwest, those states where we’ve seen so much good origination historically remain sort of the feature, I would say, little slower on the coast, but we’re still doing deals on both coasts as well. Okay. Great. And then just last for me, looking at the comments made around net charge-offs for the coming year, recognizing that ‘22 was a record year. How can we start thinking about normalized charge-offs? And then as we’re looking at provisioning levels, just maybe talk us through your thoughts on proven trajectory here in ‘23, given the broader uncertainty? Sure. Yes, I mean, you can look on Figure 15 and our net charge-off history, obviously, what a great year in ‘22 to be able to record a 4 basis point net charge-off ratio, which is an all-time low. The range that we’ve had over the last 3 or 4 years in 2020, we had 16 basis points. Obviously, there is a lot of uncertainty with the pandemic going on that year and 6 basis points in 2021 and 11 basis points in 2019. It’s hard for us to know what the net charge-off number is going to be for 2023. It’s likely to be somewhere in that range, would be our best guess based on what we know today. As it relates to provisioning, obviously, a lot goes into that. The macroeconomic factors that we get from Moody’s and used for Moody’s go into that. They did – those factors, those scenarios became a little bit more adverse compared to what they were as of 9/30. And so you saw us shift our weighting slightly, although we still are weighted to the downside through our combined weightings on Moody’s S4 and S6 scenarios. The provision in the last two quarters has greatly been influenced by the growth that we’ve had in our funded balance and unfunded balance. So the impact of our growth in funded and unfunded obviously, will impact the level of provision we have from quarter-to-quarter. And then as we get through 2023, obviously, Moody’s economic scenarios, we’d look at those during a 2-year forward projection. And so as you get towards the end of 2023, the 2 years ahead of where you are, are the scenarios that we’re looking at. And so obviously, there is a lot of uncertainty of what 2023 brings. And so when we get more clarity, that may influence Moody’s forecast to and our weightings related to those as well. So a lot of factors go into that. Obviously, the last two quarters related to the growth that we had in both our funded and unfunded balance. And you did see our overall total ACL to total commitments move up a couple of basis points in the last – both the last two quarters. Reflective of that growth and really the economic forecast you’re seeing from Moody’s and our selection of those. Hopefully, that helps. Tim, I’m going to add a comment here on something there. comment has been made that our ACL for unfunded loans is a lower percentage than our ACL for funded loans. And the question has come up previously. As funded loans moved to – or as unfunded loans fund and move to the funding category, does that mean we’re going to put up more ACL on it. That doesn’t follow. That’s not a connect, the reason that our unfunded percentage is lower than our funded percentages because RESG is a much higher mix. It’s 90% roughly of the unfunded at 60 – low 60%ish of the funded and our RESG loans are lower leverage, so they have lower risk associated with the lower loss exposure if you have a default on one of those loans. So the ACL for those loans is lower the other loans, the typical community bank loans, consumer loans, RV and marine loans, all the other stuff that is mostly funded has higher ACL allocations part. So the movement of a loan from unfunded to funded doesn’t change the allowance allocation really for that loan in any meaningful way. So I thought I might clarify that because I think there is some confusion out there about that. I wanted to talk about maybe the office portfolio, which you gave a little bit of disclosure on in your management comments, can you walk us through how much of that I think that $4.9 billion is funded versus unfunded, and kind of what the leasing looks like for some of these newer projects. Yes. yes, I’ll jump into that, Catherine. The – I don’t know exactly the funded versus unfunded dollars off the top of my head. But with respect to leasing, that as we’ve said, some of the projects we originate have pre-leasing when we originate on some or spec. And – but when we look at projects that that are complete. We are seeing continued green on the screen moving forward with improved leasing. Obviously, there is a range of results across that portfolio, but we are still seeing positive leasing momentum in those projects. And as I said, the newer stuff that we’re putting on the book is predominantly going to have pre-leasing involved with it. So on the whole, as we’ve noted numerous times, the flight-to-quality thesis, we are seeing that continue to play out, both in the loans that we have in our portfolio and in the markets generally in terms of the lease activity that we see out there. Again, there is a range of success across the portfolio, some slower than others, some knocking it out of the park. But on the whole, we’re pleased with what we see there. Great. And then on – back to the margin conversation, can you talk to us about where your deposit rates work towards the end of the quarter just to get a sense as to where funding costs might be coming as we reach the near to peak Fed? And on average – I know your CD rates kind of range in different markets. But on average, we’re a new CD is coming on? Okay. And so then – back to your previous comment, George, about NII growing from here. Should we think about that on a year-over-year basis? Or should we think about that from a fourth quarter annualized basis because you’ve seen such a big increase in your NII growth over the course of the year. So just trying to think about obviously, as the margin peaks and then fall, I think year-over-year growth is, for sure, going to happen just given the ramp we’ve seen throughout the year. But is it fair to say we could see just from this quarter’s annualized run rate, a little bit of a compression just NII at that margin falls as funding cost increase? Yes, Catherine. Yes, you’re correct. Year-over-year, obviously, we have find up the potential to have a really, really strong year-over-year comparison. If you’re comparing it to just each quarter compared to fourth quarter, I think there will be one or more quarters in which we have higher net interest income than we did in the fourth quarter. Hey, thanks. Good morning. I wanted to ask more about capital and specifically the CET1 ratio. It’s come down a little bit over the last few quarters from the strong loan growth. I’m just curious what you think about further capital deployment and what you consider the floor for the CET1 ratio? Thanks. Yes, Matt. Obviously, our growth in both funded and unfunded, has contributed to our risk-weighted asset growth over the last several quarters. We’ve got a lot of earnings power, obviously, as we’ve demonstrated over the last quarter or two, and we have the ability to do multiple capital deployments, which you saw in the fourth quarter, where we had good growth and a little bit of share repurchases. So we’re comfortable where we are on CET1. I don’t know that you’ll see that much risk-weighted asset growth that we have. Obviously, the funded growth, we’ve outlined our thoughts there on the unfunded as we approach the end of the year, the unfunded balance is likely to decline some which will give us some relief on the risk-weighted asset side. So we’ve got some internal targets on CET1. We’re well ahead of those and expect to continue to be well ahead of those as we go throughout the year. Okay. Perfect. Thank you for that, Tim. I appreciate it. And then going back to the core spread discussion, obviously impressive in the fourth quarter. The loan yields were particularly impressive in 4Q. And I think those loan betas moved up higher than 4Q versus 3Q. Any color you can give us as far as the higher betas we’re seeing in 4Q? I know Brandon mentioned some potential extension fees in 2023. In the future, do we see any of that in the fourth quarter? Thanks. I would say, Matt, that was a fairly typical run rate for minimum interest, extension fees and so forth in Q4. It wasn’t particularly low. It wasn’t particularly high. It was kind of in the range of what we would have considered to be a normal range. And I don’t think we have the expectation that’s going to be a huge factor in 2023. I think we will see a fairly typical run rate on that. I mean it will vary up and down a few million dollars from quarter-to-quarter, but that’s not going to have a big impact on our margin over the course of the year or probably more than a few basis points in any particular quarter. And George, if it wasn’t the fees in the fourth quarter, any other color on the stronger loan betas we saw in 4Q versus 3Q? Everything that was variable was off its floor essentially and the Fed was moving quickly. So we – those translates to into our loan yields. Obviously, loan yields will go up less rapidly with the Fed moving 25 basis points instead of 75 and 50. So there is – what we can do there on increasing loan yields is definitely tied to a large extent to the magnitude of Fed rate increases. Okay. And then just lastly, around thinking about liquidity and funding the growth in ‘23. Clearly, deposit growth is going to be a big factor this year. But on the securities portfolio, you disclosed kind of what the cash flows you expect this year from that. Will that be a source of funding for loan growth? Just curious if you think you could work down that portfolio in terms of size this year? And if so, how much? Matt, that’s going to depend purely on what we see as reinvestment opportunities with the inverted yield curve, and steeply inverted as it is, and assuming a likely Fed pivot seems to be priced into the yield curve faster than what we would think the Fed’s going to pivot there is not much attractive for us to buy out there. So we’re pretty much on the sidelines and letting that portfolio run off. If there is a reversal in that sentiment and we get some higher yields and a better entry point, we would buy bonds and might buy a lot of bonds if it were what we thought was a very attractive entry point. But the market seems – the bond market seems to be a little ahead of itself right now with that steep inversion in the yield curve. So, we are sidelined and we are not going to chase it. So, if we miss that in that portfolio just gets smaller and we are okay with that. One moment for our next question. Our next question will come from the line of Jennifer Demba from Truist. Your line is open. Thank you. Good morning. Just curious how the new mortgage lending operation is going? And if you have any interest in starting any other new business lines anytime in the next several quarters? Yes. We are working on the technology. We have got our three senior members of the mortgage team onboard, and they are doing all their process build and governance and risk build-out around that. We are in testing on the technology product that’s going to drive that business when we get the technology product fully vetted and tested, we will start adding some origination teams and begin doing business. That probably, Jennifer, is third quarter before we actually start that business. So – and we will start it in a small scale way and ramp it up slowly. So, that really is probably a 2024 matter that you will begin to see a little bit of trickle of results in there, late ‘23, but nothing that’s going to move the needle until possibly sometime into 2024. Thank you. One moment for our next question. Our next question will come from the line of Michael Rose from Raymond James. Your line is open. Hey. Good morning guys. Thanks for taking my questions. I wanted to start on the expense side of the house. You guys have done a bunch of different initiatives and projects kind of over the years. Just wondered to see if you had anything on tap for 2023? And then how should we think about different components, whether it would be kind of wage inflation, annual merit increases healthcare costs, FDIC costs going up. If you can just kind of contextualize the expense outlook, I would appreciate it. Thanks. Hey Michael. Yes, you rattled off a laundry list, and we have got probably more that we could add to that list. But we added a chart on Page 28, which was Figure 31, which shows you the headcount increase that we had throughout last year. And you can see that we have – really from our low point on June 30th, through the back half of the year, we added 172 people which is a 7.5% increase in the headcount. We also gave a lot of good raises throughout the year and some additional raises that go into effect 01/01. We will continue to add headcount as we go through this year. We have already gotten started in January with additional headcount. So, that headcount will continue. I mean we were really at pandemic diminished level, as we said there at our headcount. So, we needed to add back staff to support our growth initiatives. You mentioned wage pressures, those are real. Those will continue throughout this year. You mentioned the deposit insurance assessment that’s going up. And if the balances didn’t change, it would go up $1.2 million a quarter, but you also have to take into account the increase in assessments that we will get from our growth in average assets as well. Really, we will have increased advertising and marketing as we go throughout this year, similar to really probably similar to Q3 and Q4 levels to support our deposit growth initiatives. And then you have got the inflationary pressures and all of the other kind of line items, some of which are probably delayed a little bit when you think about vendor contracts that come up for renewal for 1-year or 2-year or 3-year contracts. So, all of that kind of adds up to our expectation for low-double digit increase year-over-year, full year 2023 compared to the full year ‘22. We would expect kind of in that low double-digit range increase in total non-interest expense. Well, I am sure you were about to point this out, but I wanted to at least point out that, that would still put us at a mid-30% efficiency ratio for the year, which would still be among the industry’s best. Yes, exactly. Just one follow-up, separate question. Figure 25 on Page 23, the RESG chart. So, I noticed that the LTV on the Tahoe credit was up from 79% to about 84%, 85%. Any sort of updates there on that particular credit and any sort of resolution opportunities at some point? I know it’s a longer term kind of credit, but just looking for any updates. Yes. I would be happy to take that, Michael. As it relates to the bubble floating, that has to do more with the asset mix at any given point in time. We have a few remaining single-family lots at the project and a club, and then we have got roughly – well, there are 17 town homes under construction and 34 to construct and sell beyond that. So – and those town homes have had because of the price appreciation they have had over time, when we originate those loans, they have a pretty attractive LTV on them. And then when you sell them, and start, you have got others that are not as high. It has a slight impact on your LTV. But we did close one town home sale in the quarter at a very nice price. We have got, as I have said, 17 under construction and six of those are under contract. We still feel good about the project. I would tell you that COVID created sort of a frothy pace of transactions in that market as people were really focused on getting out of town and being in a better place if they were going to have to sort of hunker down and work from home, if you will and where we definitely saw the benefit of that. It’s pull-back a bit as rates have increased, and that has affected things. But still a good mark resale prices in the community doing well. That one sale we had was at a very, very nice price point. So, as you said, it’s a long-term sort of resolution, but certainly made a lot of good progress in the last couple of years and expect that to continue, albeit at perhaps somewhat reduced pace. Okay. And then just finally, the special mention rated credit. I think that’s a new kind of addition. Just wanted to get any sort of details there if there is any concerns on your end. Thanks. Yes, sure. No, that credit is a site that was planned for a very high-end development and construction costs have escalated materially over the last couple of years. And ultimately, the borrower decided not to proceed with this vertical development there. And in light of his abandoning the development plan, we obtained a new appraisal date December 22nd, actually or December 22, which concluded an as-is value of $100.4 million. That compares to the original 2021 appraisal of $139.1 million and results in a current LTV on the new appraisal of 63%. So, the loans current sponsors actively marketing working to liquidate the property. But given the order development plan and their decision to liquidate the property, we concluded that a special mention rating was appropriate for that credit. [Operator Instructions] One moment for our next question. Our next question comes from the line of Brian Martin from Janney Montgomery. Your line is open. Maybe just one on the loans side for a second. Just I appreciate the commentary about the growth outlook this year. Just kind of wondering if you can provide any perspective on just where that growth, how you are thinking about the different buckets of where that growth comes from both from the RESG standpoint? I think you also called out kind of the community opportunities on the community banking and the ABL front. Just kind of trying to understand where the growth might be coming from this year? Brian, I would tell you, I think it’s going to be diversified again. Obviously, with the high level of RESG originations, the record level of originations in 2022, a lot of those loans will start funding up in 2023 and finish funding up in 2024. So, RESG’s funded balances will undoubtedly grow and should grow in a decent manner because of the big originations last year. But at the same time, we are getting good traction as shown in the little waterfalls there on growth in the portfolio. This last year, we are getting good traction in our ABL group and various elements of our community banking group as well as some positive momentum in indirect marine and RV. The Corporate and Business Specialties Group that chose a slight reduction in funded balances at a couple of quarters since last year has actually had nice growth in their commitments outstanding for funding. So, even that group is growing in total commitments. So, we think we are going to see good diversification and probably better contributions from some of those community bank units in the next year than we saw in the last year, and that was positive. So, we are constructive on the continued trend toward diversification in the portfolio. Yes. No, it is. And as George said, they had a good year last year, and they have got some great credits on the book, and looking at some others here early in the year. And one of the things I would note about that particular portfolio, those credits have a very nice sort of accordion characteristic to it, if you will. But defensively as sales volume pulls in, our credit to weigh ahead of that with the formulaic structure, but also as these businesses experience great health and expansion opportunities. You don’t have to necessarily book a new credit to realize a good pipeline there. We actually had three different credits expand during Q4 and was it more last night with another credit a customer that is contemplating expansion as well. So, really, really encouraged about the growth opportunities for that portfolio. Got it. Okay. No, that’s helpful. And maybe, Tim, I might have missed it, what you said earlier on the expenses, but just given that ramp up and kind of the hiring and what you guys talked about even the increases starting this year, just kind of the growth rate, or how should we think about that ramp-up in expense growth from kind of this fourth quarter level, which is obviously a peak as we get into 2023 and would it be year-over-year or quarterly, just did you provide anything on that, or maybe I missed what you said there? Yes. No, year-over-year, we are expecting low double-digit increase. If you are starting with fourth quarter, Q1 is always seasonally tough. You got a full load of FICA. You have got health insurance increases. You have got a good amount of raises that come in. So – and then you have got the FDIC insurance that’s kicking in. The increase there is kicking in 01/01. And then advertising and marketing, we are doing a lot of that right now. So, I would expect another healthy level of increase in Q1 and maybe not as much increase as we get throughout the year, but overall, year-over-year, low-double digits. Got it. Okay and that’s helpful. And then just one other one was on the a, the repurchases, just kind of your outlook there? And then just on the deposit front, just the broker deposits were up a bit. Just kind of wondering what the appetite is there, just kind of where you want to see that trend as you kind of go throughout the year or just over the next couple of years? Yes. Let me take the repurchases. Obviously, we grew a lot in our funded and unfunded balance in Q4. We purchased some, not as much as we had in previous quarters. We have got really good capital levels and a good earnings profile. I think we can do multiple things at the same time. So, we will look to be opportunistic on the share repurchase and find opportunities where we may have quarters that are above that fourth quarter number and there may be quarters where we are below that number. So, we will be opportunistic and try to find opportunities to see where we use that authorization. And this is Cindy. On the brokered, I am going to borrow Tim’s words and completely pair that and say we are going to continue to be opportunistic and disciplined and look for the opportunities that Audi and Drew and the teams are finding for the brokered. We had worked it way down, as you know. And as we get back into that space, where we are being very surgical and focused on finding the best possible opportunities we can. So, we are pleased with the way we are managing our increase in our brokered book. And the percentage of brokered is probably not going to – you are not going to see any material increase in that percentage going forward. We are in a – in our target zone for what’s acceptable on that and in our internal standards, and we are not going to materially increase it. So, you are not going to see that at 12% or 13% or 14% of deposits would be our expectation. We are not going there. So, probably sub-10% or around the 10% sort percent range is probably about the max you will see on that. Thank you. And I am not showing any further questions in the queue. I would like to turn the call back over to Mr. Gleason for any closing remarks. Alright. Thank you, guys very much for joining the call today. We are glad to celebrate a really great quarter and a great year with you. We appreciate your interest in our company and we will see you in about 90 days. Thank you so much. Have a great day. That concludes our call.
EarningCall_1448
Hello, everyone, and welcome to the Scorpio Tankers Incorporated Commercial Update Conference Call. After today's presentation there will be an opportunity to ask questions. Please note today's event is being recorded. At this time, I'd like to turn the floor over to James Doyle, Head of Corporate Development and IR. Please go ahead, sir. On the call with me today are Emanuele Lauro, Chief Executive Officer; Robert Bugbee, President; Cameron Mackey, Chief Operating Officer; Lars Dencker Nielsen, Commercial Director. Earlier today, we issued a press release, which is available on our website, scorpiotankers.com. The information discussed on this call is based on information as of today, December 14, 2022, and may contain forward-looking statements that involve risks and uncertainties. Actual results may differ materially from those set forth in such statements. For a discussion of these risks and uncertainties, you should review the forward-looking statement disclosure in the press release as well as the Scorpio Tankers' SEC filings. Call participants are advised that the audio of this conference call is being broadcasted live on the internet and is also being recorded for playback purposes. An archive of the webcast will be made available on the investor relations page of our website for approximately 14 days. We will be giving a short presentation today. That presentation is available at scorpiotankers.com on the investor relations page under reports and presentations. The slides will also be available on the webcast. After the presentation, we will go to Q&A. For those asking questions, please limit the number of questions to two. For any modeling questions, please reach out to Brian or me after the call. Hi, thank you ever so much. First of all, thank you to our shareholders, and thank you to the supporting analysts that we have. I think that, look, we entered the holiday season. We had entered in good cheer. I think that for all of you boys and girls have been good this year and own STNG, I think that you are going to have lots of presents at the end of the year. And I think that those few of you who have been a little bit naughty and are short STNG or don't own STNG, clearly not going to be having so many presents. I'd like to look at the actual press release itself and just go through the table related to rates quickly. I think it's very important. On the left-hand side, we see the rates that we booked so far this quarter. And those by themselves are -- they are a confirmation really of what we were saying in October. They're solid. They are going to beat most analysts' expectations and beat consensus, but they may not by themselves show what is actually going on out there in the market right now, and what could happen. As we can see that basically, there's about 10% of open days left. And on the right-hand side, up until, let's say, last Friday, these are the fixtures between December 1 and last Friday, we can see a tremendous gain in rates. But right now those rates themselves, up until Friday have been surpassed by what we're fixing in the market and what we're seeing in the market. So that last 10% could have quite a high delta. And that could be so high that it could materially affect those bookings for fourth quarter, even though the actual fixtures that we're doing at this time of year are starting to really be put in the book for the first quarter. So what you have here is a market that's strengthening beyond what we've got here on the table, and we have a market and we have fixtures that are closing fourth quarter higher than the averages you're seeing here, and opening the first quarter at simply extraordinary outstanding numbers that we are already at all-time highs. And these numbers that are coming in for the first quarter right now are huge. There's no other way to say that, and which you'll see through the presentation, we don't see this market backing off at the moment. We're in a real seasonal strength. We've got real coal [ph] coming into the Northern Hemisphere and we have very strong underlying fundamentals that are being respected by increases in the time charter rates. The one year charter rates have moved very strongly. And that's how I'd like to introduce this, pass it to James to start going through the details and then we'll get into some Q&A with Lars. Thank you very much. Thanks, Robert. Well, not as exciting as LR2s at $90,000 per day, but it's been an exciting year for the company, and we wanted to provide a brief update on recent events before the commercial discussion. So if we could please go to Slide 6. Strong cash flows are transforming the balance sheet of the company and improving the quality of Scorpio Tankers as an investment. In December, we gave notice to exercise purchase options on six more vessels under sale leaseback. And in total, since August, we have given notice to exercise the purchase option on 29 vessels under sale leaseback financing, which when completed will reduce debt by close to $500 million. So far, lease repurchases have been financed with cash flow, but with two new credit facilities for up to $166.5 million that were announced today, we can accelerate the repurchasing of more expensive lease financing and replace it with less expensive commercial bank financing. The new facilities bear interest at SOFR plus a margin of 1.9% to 1.925%, which is substantially lower than the 3.2% to 5.4% lease financing it's replacing. In December, we repurchased $28.6 million of the company's shares at an average price of $51.20. And since July, we have repurchased $3.7 million of the company's shares for approximately $149.3 million. And lastly, we entered into a time charter agreement for an LR2 at $37,500 per day, which is subject to final customer approval but reflects the continued improvement in outlook and rates from our customers. Slide 7, please. Well, with the conversion of the convertible bond and six additional lease repurchases, the company will reduce its indebtedness by approximately $1.3 billion this year. And the last time the company's debt was below $2 billion was December 2017 with a fleet of 78 owned vessels. So we're very excited with the progress we're making. Slide 8, please. So far in the fourth quarter, the fleet has booked an average TCE rate of over $45,000 a day. On an annual basis, this would equate to $1.3 billion in free cash flow or a little over $22 a share. Despite extending this sensitivity churn to $60,000 per day, as you can tell from the December fixtures, current rates are well above that. But in the event rates would average, say 60,000 for the year, the company would generate almost $2 billion in free cash or $39 per share. Slide 10, please. Since March, the refined product tanker market has been resilient. Rates have oscillated between $30,000 and $60,000 per day, even during seasonally weaker periods such as refinery maintenance. Recently, we've seen a substantial increase in rates. The confluence of factors and degree to which those factors are impacting our markets is unprecedented. Slide 11, please. Global inventories remain at record lows with demand continuing to outpace supply. Over the last two years, the U.S. has drawn over 471 million barrels of crude oil and refined products. At the same time, globally distillate inventories have decreased over 240 million barrels. Post refinery maintenance runs have increased. And over the last two weeks, U.S. Gulf refineries have operated at 98.2% and 97.3% utilization, and these barrels are very much needed. Higher refinery runs are needed both now, as winter approaches and as Robert mentioned, but also next year with demand expected to increase through 2023. Slide 12, please. Seaborne refined product exports have reached record levels. Product exports are averaging 25.3 million barrels per day over the first two weeks of December. With inventories near historic lows, refining capacity closures and demand increasing, product tankers now more than ever are being used to supply more immediate demand and from further afar. The impact of refinery closures in places like Europe and Australia is apparent. Both regions are experiencing record levels of refined product imports as you can see in the graph. Since lifting its export quotas, China's refined product exports have increased significantly. However, as COVID restrictions ease and domestic demand increases, it's unclear if China will be able to maintain the current levels. What is clear is that the barrels are needed. Trade routes are changing, exports are at record levels and ton miles are increasing. The incremental barrel continues to become more difficult to find. Next year, new Middle Eastern refining capacity additions will be critical to meet incremental demand, especially if there's an impact to a change in Russian refined product flows. Slide 13, please. Last week, the EU implemented its Russian crude oil import ban, stating that any vessel transporting Russian crude sold at a price above the $60 price cap is prohibited from European insurance and finance. While 1 week is a small sample size so far, seaborne Russian crude exports have declined by almost 50%. China and India have been the incremental buyers since the invasion of Ukraine. On February 5, the EU will implement a similar ban for refined products. So far we have yet to see a major shift in refined product flows. And actually, over the last two months, Russian product exports have increased, and most of the imports have gone to Europe. In the event Russian exports are rerouted to different regions after February 5, there would be a substantial increase in ton-mile demand. If Russian exports decline, refined products will need to be sourced from further afield, leading to a substantial increase in ton-mile demand. Every replacement scenario requires sending a barrel longer distance, tightening vessel supply and increasing ton miles. Slide 14, please. Next year, we expect yearly quarter-over-quarter increases in refined product demand, driven by increases in gasoline, jet fuel and naphtha with regional imbalances expected to persist due to refinery dislocation, demand increasing and the potential impacts from Russia's invasion of Ukraine. Seaborne product exports are expected to increase almost 1 million barrels a day and ton-mile demand over 9% next year. Since 2000, seaborne exports of refined products have increased in 19 of the last 22 years, even during the global financial crisis. Lower freight rate environments have typically been due to oversupply. Today, this is much different. Supply could be the most attractive part of the equation. Slide 15, please. The order book is at a record well with 4.8% of the fleet on order. Yards are booked until 2025 and using minimal scrapping assumptions, the fleet will grow less than 1% over the next three years. Using higher scrapping assumptions due to the fleet age and upcoming environmental regulation, the fleet will shrink over the next three years. Seaborne exports and ton-mile demand are expected to increase 3.6% and 9.7% next year, outpacing fleet growth. The confluence of factors in today's market are constructed individually, historically low inventories, increasing demand exports and ton miles, structural dislocation in the refinery system, potential changes to Russian product flows, limited fleet growth and upcoming environmental regulations. However, collectively, together, they are unprecedented. Ladies and gentlemen, at this time we will begin the question-and-answer session [Operator Instructions]. Our first question today comes from Omar Nokta from Jefferies. Please go ahead with your question. Thank you. Hey guys. Good morning. Thanks for the update. Clearly, a lot of positive things are happening, both in the market and your earnings and your balance sheet. And as you highlighted, Robert, 4Q now looks to be the top quarter of the year and 1Q starting off here at an exceptional or extraordinary level. I wanted to ask basically, if you could just maybe frame what's been going on in the product market recently, especially the six weeks or so since you reported earnings. What's happened to cause rates to get to this point where LR2s are earning, as you show here, $90,000 a day and $75,000 on the MRs? Yes. I'll give a good stab here. Hi, Omar. To be honest, the market back then was also very strong. What we have seen is just a continued improvement of this sustainable strength. And one of the things that we can see now as a ship owner is that we enjoy front-haul economics even on backhauls as well. So when you look at the TC1 Index as a market, it will probably print today at $70,000, $75,000 a day. And at that time, it was probably $55,000 to $60,000 a day. But the fact of the matter is that because of these huge exports out of North Asia, where the destination optionality has really kind of presented itself with a lot of kind of chances and options for the owners. So we are moving LR2s now out of North Asia down to Singapore at, let's call it, $100,000 a day. We're moving it at $110,000 a day or $120,000 a day into Australia. We can reload out of Australia with condensate, which is also a nifty thing for the LR2s, which with backhaul economics into the AG is also presenting itself with about $80,000 a day. What we've also seen as we moved into the back end of the fourth quarter has been an increase in exports as well coming out of the Mediterranean. So there has been an active market of light ends moving from the Med going back to Asia. So as we have been fixing our ships with distillate into the Continental, into Mediterranean we have been able to quite successfully being loading vessels as well out of the Mediterranean and the Continent back to Asia. What we're seeing here is an elongation of positions. So if you look at the position is today on the 14 of December in the Middle East on LR2s, you are seeing probably the tightest position is that we have seen for a very long time. And it is my view that we're going to start seeing that market to react as well even more positively. So today, it's probably printing at Worldscale 305, trading $85,000 on pure round voyage. But in reality, because of all this capacity that we can see in terms of triangulation, rates are going to be substantially higher from that. Thanks Lars. Yes, it sounds like that $90,000 and $75,000 are low relative to what you're seeing today. And I guess I wanted to make sure, James mentioned this, but any of what we're seeing today coming as a result of the Russian ban at least on products coming in February? Or is that still a catalyst to come? I believe it's a catalyst that's going to really show itself as we move past the 5th of February. We have obviously seen a lot of the same molecules moving from the Baltic and the Black Sea into the same European destinations, and that is still continuing. And as James said, we've seen an increase in volumes as we're ramping up the stocks as much as Europe can do up to the 5th of February. But the fact of the matter is, and this is really important, is that it doesn't matter what market you're in. You can be in the Far Eastern market, you can be in the Middle Eastern market, you can be in South America or in the U.S. Gulf. All markets on all sizes are ramping up. So you don't have any weaknesses where you could say that positions are being moved from that area to another area. You've got good market or very, very good markets in all areas at the moment, irrespective of what's happening with Russia. Now clearly, what we have been seeing over the last couple of months has been this increase in imports into Europe of distillates in particular. But as we go past that fifth of February deadline, replacement products will ultimately have to travel further. And the ton miles will certainly also increase for the LRs and also for the MR product carriers. So one thing, of course, you've got refineries that are running even harder. You've got high utilization rates across the board. The potential of some of these tripping over will increase due to the way they run them so hard, which, of course, will also increase the dislocations and the arbitrages start moving up even further. So there's certainly plenty of product that we've seen to move. We can see increase in volumes both in China and also in the Middle East and also products out of West Coast India, all of it going long-haul and it's not necessarily only going to Europe. But we're seeing also stuff going to West Africa, to South America and so on. Again, we're seeing this optionality on destination, which certainly for a ship owner who wishes to triangulate very effectively is very good news. Got it. Yes. Thanks for that additional color, Lars. And one final one for me, just on the three year charter, on the LR2, the $37,500 is the new high, at least, I think, from what we've seen in the market recently. You noted that this is on a forward delivery basis. Just wanted to get a sense from you guys, how far forward is that deployment? And any thoughts on why the charterer doesn't take that ship today. I think -- well, I think we -- that one is still a subject position, I think, we'll just say for the first quarter somewhere first quarter. And the why is not the charterer the why is partly too as well. I mean, obviously when the market is hot, you're not necessarily, even if it's a great rate like $37,500 for three years, you're still not anxious to -- we're not very anxious to fix our tonnage out. We've got a very high spot position. We're very confident to the present market. I would leave it at that. I think I'll just add to that, Omar, that in terms of activity in the time charter market and the inquiry levels that we're seeing in our project department, it certainly has not abated. I mean there's plenty of interest from top tier customers wanting to take long-term charters going forward. Thank you. Hi guys. The market's really strong. Yes, it is strong. It is strong, yes. So $90,000 per day for LR2s in December. Considering that the market is improving by the day, could you tell me what's the outlook in the next future? Hold on, just want to say. Lars has already said that he's fixed me a higher than the $90,000, now fixing in the $100,000 on the LR2s. I'd first sort of -- I know you stuck your neck out and said that a while back when it was quite controversial at the time that we would see $150,000, $200,000 a day on LR2s this winter. I would just like to comment that you're going to see $150,000, $200,000 a day on most probably this winter, but you're probably actually going to see that on Handysize vessels first. That will give you credit for your, what was at the time, thought to be by some as a very extravagant call. So Lars, I don't know if you want to add to that. It would not surprise me that this winter, we will see over $100,000 on Handies or MRs or LR2s, which obviously LRs is already doing. I think all segments are on fire. Perfect. That's great. I guess my next question is, in order to explain this because February 5 hasn't happened yet, right? So have you seen any unusual product arbitrage movements in recent months? And in connection with that, are maybe ballast lengths increasing? I would say Frode, to answer your last question, ballast lengths at the moment are decreasing. We're seeing a lot more triangulation on LR2s than we've ever seen. We're seeing a lot of triangulations on MRs as well. So -- it certainly is not increasing. When it comes to the first part of the question, we're seeing a lot of product, as I mentioned earlier, coming out of the Middle East. They're certainly ramping up in Jizan. They're ramping up in Azure. They've also kind of increased their production in West Coast India. And of course, with the high processing that we've seen in China, I think the exports going to Europe that has trebled just this year alone. So we're seeing a lot of volume. It's not only going to Europe. It's also a lot of it's going down to Australia, as we mentioned before, a lot of it is also going to South America. We're seeing volumes going long-haul longer haul than we've seen before going into Western Africa as well. So in terms of ton miles, it's not only is it defined by the fact of preparing ourselves for the ban post 5th of February, but it is fundamentals around the globe that there is kind of pushing this market into this great strength. Yes. That's good color. I guess on the ballast length, I guess at least the Russian products could be argued to be -- have to be moving on more inefficient round voyage basis. What do you think? Well, come the 5th of February, and obviously, this is what we assume is that the dark fleet as what's been called now, will be moving this product further afield as well. They would -- because they're only going to be doing Russian, they'll be ballasting back. So that is inefficient utilization of that particular fleet, which, of course, certainly means that your utilization of the normal fleet will increase and will fundamentally contract the supply overall. Hey, guys. Good update. Appreciate it. Robert, you had mentioned that at this point, you guys are already beginning to fix spot into 1Q. Just curious if you can maybe frame in how much of 1Q you already have booked, and are they the kind of the rate levels that you have laid out in the press release there? Well, the rate -- we haven't guided to how much, so I can't do that. But the rate, what I could say is we could infer that they would be at the -- up until Friday we closed down on Friday that you would infer that basically a lot of the fixtures that were done between December 1 and last Friday at those averages, you can see of $90,000, $75,000, $55,000 would be the, let's say, the starting rates of Q1. Right now, this week, if you're talking about an LR2 that fits kind of longer voyages further forward, they're going to be starting -- you're starting now putting fixes in the books for this week that aren't in those calculations there. Those calculations only went up to last Friday, as Lars is saying some of the fixes are going in at plus $100,000. So and as you chop through each week, more and more of the voyages go into Q1. So basically, by the end of December, end of this year, you would have definitely had, let's say, the first three weeks of Q1 booked which on the present rates, just think what those first three weeks could be at present rates, those three weeks, you could virtually earn what you earned in the third and the fourth quarter in the first three weeks. By the time you get to everyone comes back on January 10, you'll have 33% to 35% of the entire first quarter book. That I think, is what's super exciting is that these rates are so high and have such depth and breadth that they have an immediate effect related to your earnings and your cash position on your balance sheet. So I would just say you can count it backwards. If it's 33% by, let's say, January 10, then if you chop back a week, then take away 8% from that, chop back a week again, another 7%, 8%, that's how to approximately calculate bookings forward. Okay. That's helpful color. And then as it relates to just sort of the market and appreciating that as Lars you laid out, the February sanctions that could be a catalyst or create inefficiencies that effectively shrink the size of the fleet. How should we think about next year's refinery maintenance season or turnaround season, that sort of coincides with -- we're pretty close to when the sanctions are coming in. I mean how does that -- I don't know, how do you square the circle on how all of those things are going to operate simultaneously. Well, if we look at 2022 in terms of what that seasonality meant, when it comes to refinery turnarounds, we had full steam ahead in the second quarter, the third quarter, which tends to be the strongest part of refinery maintenance period. I think we're down to 2.2 million barrels. That outage in December for this month compared to October was 7.6% and in October, the market was also just as strong. I think that the underlying element of what we're seeing today with capacity utilization, theoretically is so high now that with no kind of extenuating type of bottlenecks. So this is structural. So in terms of saying that there's a refiner that has to go into turnaround, they will have to supply them with a smaller fleet of ships available to them and take that further afield. And I only see that this market will kind of ride through any kind of seasonality in terms of refinery maintenance and maintain its strength. Hey, Great. Congrats on finally getting to this point working through what was certainly a longer downturn than you thought. I guess, Robert, does the interest -- if you're getting so much interest in time charter outs and you keep pushing it off, and rates keep going up too, does that ever turn into orders from the major? Maybe talk about the cost of newbuild details? I know there's not much of an order book, but what's going on in the market now? I guess I'm -- in our analytical view, when things are too good, something typically goes wrong. Yes, I think that's a great question. I think at the moment, it's in an okay place. It's actually in an okay place for a major -- they've been able to take -- there's enough of the discount in the time charter rate, whether it's one year. I mean one year LR2, I think Lars was telling me this morning is in $50,000, $55,000 a day. So at all points, the $50,000, $55,000 or the three year rates, et cetera. The charterer is getting kind of a profit on the first part of it. So that's kind of a comforting thing, to secure tonnage for a period while getting a profit on an extremely strong market. So they're able to get coverage when they are short tonnage at some kind of present cash flow. Whereas, if they were to translate that into a newbuilding, they're not doing anything. They're not getting that ship for years. It doesn't do anything to alleviate the problem at the present, and they have cash out. The further down the curve, you get the more uncertain, or everyone were discounted, and they've just left themselves massively exposed to the front. So unless Lars has anything else to add, having worked for a major, the calculation right now is what we're happy to do a three year charter if we can. And why would we go upstairs and order something at record prices for something in the future that does not help an extremely stressed position in the present. Yes. Makes a lot of sense. James, you talked about the opportunity to take down debt faster, obviously. I think you originally were, I think something like $300 million, now you're talking the cash flow can be up to $1.3 billion. Are there any constraints as you look into next year on what you can draw down? And then Robert, we typically -- you always tell us to wait until Thanksgiving and see what's going on with rates. Obviously, this looks just completely different than a normal calendar. So maybe is there anything on the horizon that seasonally switches this? Or is it just going into refinery maintenance that you were just talking about? What changes the kind of run here seasonally? Sure. So Ken, we did six more leases for the end of this year. We still have probably 60 vessels or more that are under leases. So there's definitely more to do. Recently, we've been doing it through cash flow. And obviously, over the next year, we'll have new loans as these vessels are unencumbered, and we can draw down on those loans and then accelerate those repurchases. Obviously, the financing in terms of the commercial bank loans are really attractive. And so we're going to continue to look to do that. And then at some point next year, you'll start to see the impact on kind of lower interest and principal breakevens, which we're really looking forward to. When it comes to the rates right now, when I look at it, it's very hard to -- you can think of things that are going to push the rates even higher, such as the February 5 situation because in products, it's kind of maybe even more wacky than crude because there isn't so much of a dark fleet in products. And even if in the dark fleet itself is likely to be -- it's not like they're going to be taking products to China or products to India in the same way the crude oil market is. They're going to be taking products to South America or points in Africa, so huge long distances that's going to occur. But these are all things that we can just create even more bullish constructs. And you can see from what we're talking about now, we kind of don't need that. The market is already -- it's moved from, I mean bullish is now too weak a word for it. I mean, I don't know how to describe something that's moved from bullish to very bullish to red hot. I mean, white hot. I don't know what's after that. And it's very hard now you've got winter. We actually got a winter now in the Northern Hemisphere. And I think that that's putting a check into because we've seen the attempt to inventory building. We've seen gas being built. We've seen some form of energy complacency despite the fact that world inventories are low. And then suddenly, you're getting this shock coming in with extreme cold. So because of the season itself, nothing to do with Russia, because of the season itself and the actual capacity of the supply side capacity at the moment, it is hard to think that this market is going to be anything but strong for this sort of -- during its normal seasonal period, which would normally last all the way through to -- with a little bit of a hiccup with refinery maintenance through tell, let's say, early mid-June. Hey, thank you, and good morning everybody, and thanks for the update. James, I did have a question around the fourth quarter percent of days fixed -- and kind of really what I'm looking for are like as we think about plan days and maybe some unplanned days for the quarter, is there any kind of guidance you can give us there in terms of as we think about total revenue days for the quarter? And then also with that, sometimes we see like a ballast leg of a vessel. We see that a lot in crude where maybe it's not -- ends up being like some zero revenue days. Could you provide us any color around that just as -- I think that would be helpful? Yes. So there was some additional off-hire days and those were updated in the MRs. So those came down, and that's because the dry docks are taking a little bit longer due to COVID restrictions in China. In terms of rates generally, I think what we see, which is probably a little bit different than crude and probably mutes this a little bit more is the triangulation. And the triangulation on the MRs is obviously pretty well known, where it's very surprising now is what Lars and his team has been able to do on the LR2s. And I'll let him speak to that. But what you have is an incredible amount of distillate that needs to go from Asia to the West. And so it's creating some very, very nice backhauls. And it's also benefiting the MRs as well. And that's really when you look at kind of benchmark rates and where we are, how we're benefiting from that. I think if you look at what we're doing now in the current update, you're seeing the benefit of that triangulation. And that's probably the biggest difference compared to crude. Great. And then I did have a question. As we see more realizing that the MR market in the Atlantic Basin tends to really be, we fix it and we get to work. As we see more cargoes or loadings out of the Middle East, as those refinery runs -- as their refinery volumes increase. is there any way and I think, Robert, you touched on it a little bit, the way to leg [ph] as we think about fixing forward, i.e. or we look at today on -- today's mid-December, is kind of the actual loading time for that vessel that's fixed today? Is that kind of 7 to 10 days? Is that like a 7 to 10 days ahead of its actual loading and starting to realize that rate? Is that kind of a fair or a rough way to think about it? Yes. I'll start with -- look, Greg, on an MR, it's 7 to 10 days. It can be -- it can vary a little bit depending if it's east or west or it's the U.S. Gulf and the U.S. Gulf tends to be even shorter than that, could be 3 to 5 days. When it comes to MR2s, it tends to be anywhere between two weeks to three weeks out, depending on where that particular low port is, but mainly for the Middle East, it will be two, three weeks out, probably two weeks when it comes for North Asia, and it is a little bit more tricky when it comes to loading out of Australia with the condensates where that can be also even further out, and you need to make sure that you have enough ships there to kind of maintain the late cans. But that's about right. Okay. Great. And then I just did have one other question, just as we think about it, everybody is seeing the impact of the crude oil embargo in the Turkish rates and the locking up or I guess the authorities are trying to prove out where that crude on those vessels was originated from. As we think about the product market and the upcoming embargo of -- that's taking hold in early February. Everyone knows the headline numbers of Russian refined products, seaborne exports. Any kind of rough guidance or you could talk about in terms of what's coming from that region as opposed to what's coming out of the Baltic? First of all, there's more product coming out of the Baltic than out of the Black Sea. My first point -- the first point in terms of the issues around Turkish Straits, it is -- at least to my knowledge, now has been sorted out here with the P&I clubs with a wording that has been adapted or adopted by the different players, and ships are now transiting through. And the funny thing is, it was more because of the vessels loading out of kind of CPC with the Kazakh crude, which, of course, is not sanctioned, making sure that, that P&I coverage was in place. And we have seen now that, that has now sorted out. When it comes to the volumes out of the Black Sea, post 5th of February, it's a very, very good question. It certainly is all down to what supply of ships is available in the dark fleet to be able to move it because they were trying to do whatever they can to maximize that, but I think they're going to have an issue with finding enough ships to do so. Ladies and gentlemen, with that, we'll conclude today's question-and-answer session. I'd like to turn the floor back over to Robert Bugbee for closing remarks. Thank you. Thank you very much, everybody. I'd just like to cover something that wasn't covered. I mean, we've been bullish. We've been very bullish, and we even talked on the last conference call about $82 NAV by the end of March. Clearly, we haven't been bullish enough. I mean this is -- we just want to serve in a way it comes for you guys that, wow, this is especially now with the cold coming in and the various government policies are just continuing to run down the inventories and not implement either driving speed limits, et cetera, you're creating an amazingly tight market here. And that $82 a share NAV is no longer optimistic. It's no longer even that bullish. It's fast becoming a reality and very quickly becoming a reality. So I know we haven't talked about it much on the call, but you've got 2 things coming in. It's not just the earnings, it's the value too. So it's a great position. We wish you all a very happy holidays, and thank you again very much for your support and your trust. Thanks. Ladies and gentlemen, that will conclude today's conference call and presentation. We do thank you for joining. You may now disconnect your lines.
EarningCall_1449
Good day, and welcome to the INDB Independent Bank Corp. Fourth Quarter 2022 Earnings Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Before proceeding, please note that during this call, we will be making forward-looking statements. Actual results may differ materially from these statements due to a number of factors, including those described in our earnings release and other SEC filings. We undertake no obligation to publicly update any such statements. In addition, some of our discussion today may include references to certain non-GAAP financial measures. Information about these non-GAAP measures include reconciliation to GAAP measures may be found in our earnings release and other SEC filings. These SEC filings can be accessed via the Investor Relations section of our website. Please also note that this event is being recorded. Good morning, everyone, and Happy New Year. Thank you for joining us today. I am once again joined by Mark Ruggiero, our Chief Financial Officer; and Rob Cozzone, our Chief Operating Officer. As I'm sure most of you know by now, we recently announced my decision to retire as CEO after 20 years at the helm of our terrific bank. There really is no mystery here, just customary thoughtful succession planning overseen by our independent directors. The decision to retire was mine. I am healthy and well. And after two decades just felt it was time to pass the baton to someone else to lead the next phase of our growth and long-term success. The Board has made a great choice in Jeff Tengel to lead that effort. Jeff will formally assume as CEO role on Monday, February 6. I'll remain an Executive -- in an Executive Advisory role until the end of this year. I will also continue to serve as a Director until my term expires in May 2023. The CEO transition does not reflect the change in our strategic direction whatsoever. Also after many years of succession planning, we recently elevated two long-term commercial colleagues, Jim Rizzo, Catherine O'Malley to our executive leadership team, both will continue to report to our President, Gerry Nadeau. On the earnings front, we capped the year with another strong and fundamentally sound performance. Net income in the fourth quarter rose to $77 million or $1.69 per share. Mark will take you through the quarter shortly, while I'll be focusing my comments on the full year just concluded. Financially, it was another -- in a string of strong annual performances in a difficult economy, our operating EPS grew by 8% in 2022. Loan activity remained robust with commercial loan closings rising 14% to $2.1 billion of combined residential mortgage and home equity originations totaled $1.2 billion. We continue to generate record level of consumer checking account openings and core deposits comprised 88% of total deposits. Astute balance sheet management drove a 44 basis point improvement in the full year net interest margin. The strength of our investment management business was on full display this year, as strong new inflows totaled $1.2 billion, way above previous levels. Our assets under administration or management increased versus a year ago to $5.8 billion despite the sharp decline in market valuations. Now one fun footnote or historic footnote I'd like to share with you is, that the $1.2 billion of new money in 2022 is almost 3 times the total assets of our management we had when I arrived in 2003. This business has come a long way. Credit quality continued in excellent shape with a total loss rate of a mere 1 basis point for the full year. Capital remains at Apple levels, which accommodated ongoing share repurchases and healthy dividend increases and expense levels are being well managed, bringing our operating efficiency measure to nearly 50%. We also made significant strides in advancing our franchise on a number of fronts. Most significant has been the seamless integration of East Boston Savings Bank, our largest acquisition to-date, which has materially strengthened our presence in the coveted Boston market, while being both accretive to both earnings and tangible book value. We continue our expansion in and around Worcester, the second largest city in Massachusetts Customer reception to our brand has been excellent. We continue to make critical enhancements to our digital banking offerings, covering a full range of account access and openings, payment networks and front-end loan processing. And our ability to attract experienced senior talent into our company continued throughout the year, including the hiring of a Chief Risk Officer successor, and this will enable us to capitalize on the new business opportunities arising out of our larger size and expanded footprint. Now looking ahead, our near term priorities lie in the following areas: talent, a real focus there to accomplish our long-term goals and capitalize on opportunities, building our businesses in areas where we enjoy competitive advantages, streamlining and modernizing to remain competitive and nimble while keeping pace with the rapid technology advances. Our branch network optimization continues, finding the right balance between the physical presence and satisfying the widely varying preferences of different generational consumer groups. Of course, ERM, Enterprise Risk Management continues to evolve, ensuring that our risk management infrastructure and skill sets keep pace with our growth and of course, continued integration of new businesses and new colleagues. We must continue to develop and motivate our colleagues to meet the challenges both organic and acquired growth. These priorities are all supported by detailed plans, which will prove a great help to Jeff as he comes on board. A few quick observations on the economic front. The job market continues to be a bright spot for e-comm (ph) activity with consistent and strong payroll cranes, but retail sales printed back-to-back monthly declines and points to a cooling in the overall ECA (ph) activity, which may be consistent with the recent inflationary reports showing signs of easing with broad-based declines in prices. The Fed remains hawkish, and as indicated, there is more room for rate hikes in 2023. So as a final economic prognostication as CEO, I'll say that while the risk of overtightening shouldn't be overlooked, the window for a soft landing remains a possibility. So before signing off, my last of 80 earnings calls, I'd like to say that it has been an honor and a privilege to serve as CEO of INDB and Rockland Trust for the last 20 years. I've seen our company grow from $2.3 billion in assets to nearly $20 billion from annual operating income of $24 million to $269 million. Our market cap is going from $339 million to $3.9 billion. Our investment management grew -- asset investment management from $334 million to $5.8 billion. Now from my precise February 24, 2003, CEO start date, share price has increased 305% versus a KBW Bank Index increase of 42% and NASDAQ Bank Index increased of 84%. Tangible book value per share has grown from $8.64 to $41.12, an increase of 376%. We've accomplished a great deal by nurturing and building a relationship-oriented culture of care and respect. And we believe that a great place to work in retaining excellent colleagues is the essential foundation of a high performing bank over the long term. We've been recognized by the Boston Globe Top Places to Work employee survey for 14 consecutive years. And we've earned high rankings across a range of customer satisfaction, service and loyalty categories, as surveyed by J.D. Power, Greenwich Associates and Forbes, among others. J.D. Power currently ranks as number one in retail customer satisfaction in New England. I'm extremely proud of all my colleagues. Now while culture may start at the top, our entire team deserves credit for the culture of the bank and the success and momentum of INDB. I am so grateful that I've been able to work alongside my amazing colleagues to build INDB into what it is today. I can't thank them enough. They've been extraordinarily engaged and resilient over the years and bring so much enthusiasm and passion to excel day-in, day-out. My successor, Jeff Tengel will benefit from a deep an accomplished executive management team, including Rob and Mark, who are here on this call with me, and I'm deeply indebted to all my fellow executives. Together, we have been focused, discipline and unwaveringly committed to nurturing a culture of the banks and have produced consistently solid results over a long period of time. I will truly miss leading the bank with them. I'm also grateful to our Board of Directors for giving me this opportunity in 2003 for their unflagging support of me over the last two decades through good times and occasional difficulties. And finally, I wish to thank you the investment and analyst community for your support. We've always maintained an open and honest dialogue. I have learned a lot from you, and I thank you for your interest and insights. Thank you, Chris. Certainly, a tough act to follow, but I will now take us through the earnings presentation deck that was included in our 8-K filing and is available on our website in today's investor portal. Jumping to Slide 4 of that deck. To summarize results, 2022 fourth quarter GAAP net income was a company record $77 million and diluted EPS was $1.69, reflecting 7.2% and 7.6% increases, respectively, from prior quarter results. In addition, the fourth quarter results produced a 1.56% return on assets, a 10.70% return on average common equity and a 16.57% return on tangible common equity, all up significantly over prior quarter results. Regarding tangible equity, the tangible book value per share increased an impressive $1.56 to $41.12 as of December 31, reflecting strong earnings and stabilized other comprehensive income. There were no share repurchases during the fourth quarter. As we move our way through the deck, we will hit on the additional details behind the quarterly performance key drivers noted here on the slide. Turning now to Slide 5. We provide a high level summary of our loan portfolios for the quarter. And as noted here, reported balances for the quarter increased 1.7% or 6.6% on an annualized basis. As anticipated, with the rising rate environment, payoff and refinance activity decreased when compared to prior quarters, which, along with the strong closing activity. Chris noted, fueled solid commercial loan growth across both C&I and commercial real estate. Residential balances also increased nicely but at a slower pace than prior quarters. Slide 6 provides some additional details around the loan activity for the quarter. As I just alluded to, new commercial commitments for the quarter were strong at $636 million, up over 20% from the prior quarter. This naturally drove a decrease in the approved pipeline from $383 million last quarter to $317 million at year end. However, the current balance should still bode well for good closing activity heading into 2023. And as noted on this slide, you can see the majority of activity is in the asset classes and industries we've been referencing for most of the year. On the right side of the slide, consumer portfolio closings were down compared to the prior quarter as expected with the vast majority of Q4 residential volume once again placed into the portfolio, driving the solid balance sheet growth. Moving now to Slide 7, the combination of inflationary pressures impacting customer liquidity and competitive pricing led to a 2.8% decrease in overall deposit balances. New account opening activity remains strong, but it's no secret, we are in a different deposit environment than we were just a few quarters ago. As such, we remain focused on core relationships and operating accounts while addressing pricing pressures where needed. As noted on this slide, the majority of outflow occurred in our business savings and money market balances with consumer balances experienced and some net flow as well while the CD product set served as a compelling alternative to retain some level of higher rate sensitive customers. As expected, these dynamics resulted in an increase in the cost of deposits to a still low 35 basis points for the quarter, up from the prior quarter level of 15 basis points, reflecting the inherent value of our deposit franchise, based on the effective date of the Federal Reserve rate hikes, the total deposit beta for the quarter was 14%, with the cumulative beta on all deposits at only 8.4% or 13% when isolated to only interest-bearing deposits. However, we do not deny that pricing pressure has increased, and we will touch upon deposit cost outlook in our forward guidance. Slide 8 reflects our customary snapshot of the reported margin as well as a breakdown of volatile or non-recurring items to reconcile back to a core net interest margin. The 21 basis point increase in margin and 23 basis point increase on a core basis is right in line with previous quarter guidance and a reflection of the asset sensitivity positioning noted in the bottom right of the slide. With absolute levels of cash significantly reduced, our overall asset sensitivity has also been reduced with the balance sheet well positioned to manage interest rate risk heading into 2023. Moving on to asset quality. Slide 9 provides some key metrics worth highlighting. Addressing the key notable development referenced in the earnings release first, the C&I credit making up the majority of that category's non-performing balances in both Q3 and Q4 is still in workout. Though still very fluid, a specific reserve allocation of $14 million has been built over the last two quarters and is reflected in the provision levels already recorded with actual charge-off amount in the 2023 timing still being assessed. Not surprisingly, the now delinquent status of this loan is the main driver of the fourth quarter increase in the overall delinquency rate. Aside from that one loan, no other pervasive credit concerns are noted with non-performing assets staying relatively consistent at $54.9 million and negligible charge-offs of only $394,000 for the quarter or 1 basis point annualized. Shifting gears to non-interest items. Slide 10 provides details on the strong net interest income results for the quarter, a few of which I will highlight. Decreases in deposit account interchange and ATM fees reflect typical seasonality. Regarding investment management income, the significant increase in revenue reflects continued very strong new money inflows, as Chris noted, solid market performance, strong retail commission income and a one-time non-recurring earned incentive of $650,000. Though a portion of the growth is tied to a meaningful increase in customer demand for shorter-term cash strategies, the increase of assets under administration from $5.1 billion last quarter to $5.8 billion at year end is a testament to investment performance as well as the inflows generated from the relationship synergies developed over many years between wealth and bank colleagues. Loan level derivative income increased nicely as customers have become more comfortable with expectations over the pace of future rate changes. And lastly, other non-interest income includes a $900,000 gain on the sale of a previously closed branch building. Turning to the next slide. Total operating expenses of $94.9 million reflect a 2.3% increase from the prior quarter. While the quarter contains some specific notable variations to the prior quarter results, such as changes in the fair value of split dollar insurance obligations and increased technology spend, the overall increase is in line with expectations. And lastly, the tax rate for the quarter dropped to 23.2% as the fourth quarter typically reflects some level of discrete adjustments related to the filing of the corporate tax returns. We'll now shift gears to Slide 12 and cover 2023 forward guidance, which will obviously remain fluid throughout the year. With the level of overall economic uncertainty still at play, we expect overall loan growth in the low-single digit percentage range. And with the payoff activity in commercial real estate decreasing from 2022 levels, we should see more balanced growth across both the commercial and consumer books. As deposit pressures continue, we anticipate additional decreases in balances in the first quarter of 2023 in the low-single digit percentage range. Though, we will remain focused on customer acquisition efforts, insight into deposit balance volatility for the rest of the year is difficult to predict at this time, and we will certainly provide quarterly updates on deposit balance expectations throughout the year. Given the current balance sheet profile at year end, we anticipate securities will attrite modestly over the course of the year, while cash and/or some level of wholesale borrowings will be a function of actual loan and deposit activity throughout the year. Regarding net interest income, we currently expect loan yield betas to stay in the range of 20% to 25%, reflecting the overall composition of portfolios tied to short-term rates, combined with the $1.45 million current macro hedge portfolio. Deposit betas are expected to continue to increase from prior quarters with the cumulative total deposit beta to reach approximately 15% through the cycle. In terms of shorter-term guidance, assuming an early February 2023 Fed reserve rate increase of 25 basis points, we expect the net interest margin to expand in the first quarter by 3 basis points to 5 basis points with a reminder that fewer days during the first quarter will drive lower net interest income results on a relative basis. Regarding asset quality and provision levels, we think it's prudent to keep our guidance anchored more in the near term than a full year outlook. As the previously mentioned large C&I loss estimate has already been provided for future provision levels will continue to be driven by loan growth, any future migration of asset quality metrics or changes in the overall economic outlook. Regarding noninterest income, despite an anticipated late Q1 change in our overdraft program anticipated to reduce 2023 fees by approximately $3.5 million, total fee income is anticipated to grow by a low-single digit percentage compared to 2022 totals. Key drivers of the growth are expected in deposit account interchange in ATM given the focused growth on core operating accounts, continued growth momentum in wealth management, though likely not to the degree experienced in Q4 and a continued demand over loan level derivative product driving fee income similar to the levels noted in Q4. Given the reduction in mortgage refinance opportunities and decreased pipelines, mortgage banking income will continue to be challenged for much of 2023. Regarding more immediate guidance, given the increased level of non-recurring fee income noted in the fourth quarter and reduced level of days in Q1, Q1 fee income is expected to be down a high-single digit percentage when compared to Q4 levels. Regarding non-interest expenses, inflationary pressures increased investment in continuously improving the customer experience and some one-time items associated with the recently announced CEO transition are expected to drive increases in total expenses in the mid to high-single digit range for the full year as compared to 2022 operating levels, which exclude M&A. In terms of more immediate guidance, Q1 2023 expenses are expected to increase at a low to mid-single digit percentage over 2022 Q4 levels. And lastly, the tax rate is expected to be in the 24% to 25% range for the full year. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Mark Fitzgibbon with Sandler O'Neill. Please go ahead with your question. I just wanted to start by saying, Chris, congratulations on your retirement. You've done an absolutely amazing job at the helm. Congrats. First question I had for you. You referenced in your early comments about the investment management business. You had about $470 million of net flows this quarter. Did that come from existing clients or did you bring in some new teams that really drove that? Yeah. A little bit of both, Mark. We had a couple of hires in 2022, one of which really was very successful in tapping into his connections and networking and brought in about $80 million of gross money during the year. I also mentioned we really found a good opportunity given the rate environment to work with both existing customers and some new customers who are looking for more shorter-term treasury security cash strategies and that equated to about $240 million of new money in the year. So that's a little bit of a different kind of product set from our typical wealth management business, but I think a good reflection of really leveraging the retail bank and being creative to look for opportunities, given the interest rate environment. So those are really the two drivers. But the team still finds really good opportunity in our typical larger wealth products. We talk a lot about the long standing relationships that our wealth advisers and commercial lenders have created over the many years, and you're really seeing that on display lately. Yeah. Just Mark, one thing that I want to add to this is that the code that we cracked a number of years ago is the -- completely eliminated any reluctance from the vast majority of our commercial lenders and the branches to working with wealth and providing referrals to wealth. So a stumbling block that exists in many other financial institutions. Yeah. Just in -- we actually switched a couple of our wealth products to a different platform. And the third-party we're using for the new platform, incentivized us to make that switch. So there's a one-time fee associated with the transfer of that money from a platform perspective. Okay. And then I know credit is not really an issue, but a couple of quick credit questions if I could. That one C&I loan that you've already provided for, I think you said you had a $14 million reserve against it. Do you think that's sufficient to be able to cover the charge that you're expecting to take? And when will you -- do you anticipate taking that charge? Yeah. At this point, we feel that's sufficient. As I noted in my comments, there's a lot of moving pieces to it. So obviously, actual loss is still somewhat undetermined at this point, which is why we have not taken a charge-off and have taken a specific allocation. But there's really additional work being done, the company did file bankruptcy, and there is a liquidation expected of the company which will drive collection on receivables. That's our primary collateral. So it's truly just a function of how well those receivables hold up in terms of what sort of repayment we'll get through the process. We expect that timing, unfortunately, to linger a bit. This is a large, syndicated deal, many banks involved. So I wouldn't anticipate a charge-off. Well, I wouldn't expect full resolution in the first quarter, whether we'll be in a position to take a charge-off is still to be determined. Okay. And then lastly, can you remind us, Mark, how large your Boston office book is and maybe what the average LTVs and debt service coverage ratios look like on that? Sure. I have the dollar amount in terms of true downtown Boston office exposure is about $240 million in balances, a little bit higher in exposure. I think it's important to note, included in there is about $50 million of owner occupied. So it's a portfolio we feel really good about and is quite small in regards to the total office portfolio of about $1.5 billion. There are some other exposures in neighboring cities like Brighton, Jamaica Plain, that's probably another $80 million to $100 million in total balances. But we feel good about the exposure. I don't have all the LTV and debt service metrics in front of me, but I do know that those have been faring well. And we're not seeing anything from a pervasive control by any means -- a pervasive concern at this point. Maybe just starting off on the margin and NII outlook. Just curious, where is loan pricing these days? And then if we think about the Fed, moving to stay around 5% on Fed funds and holding there for the rest of the year, how are you guys thinking about that margin trajectory? Sure. Yeah. So the first element of your question, Steve, in terms of new volume. Certainly, from a fixed rate perspective, we continue to see the lift of the increase in rates. So for the fourth quarter, keep in mind, there's a bit of a lag in terms of when loans are committed to versus when they hit the books. So focused primarily on new out standings for the quarter. We saw fixed rate pricing on the commercial side certainly move north to the high 5% to 6% range. For mortgage, it was more in the mid 5% range in terms of what got booked in the quarter and similarly, home equity slightly north of that. So obviously, a reflection of the rising rate environment. We've seen good churn over in terms of the yield on new volumes getting booked. In terms of longer-term margin guidance, we talked about the 3 basis point to 5 basis point increase expected here in the first quarter that would be a function of expectations around the Fed raising 25 basis points in their next meeting, which is late January or early February. If they do another 25, as you indicated, to get to that 5% Fed funds target, I think you'll find that the continued pressure on the deposit pricing will certainly mitigate really any meaningful increases of asset repricing going forward. So I think you'll see the margin. Our expectations would be that would kind of get stabilized around that high $3.80, $3.90 range, if that forward curve plays out as you indicated. Okay. And maybe just on the deposit pricing side. I've assuming that you probably think of -- if we're holding here and deposit pricing continues over the course of the year, kind of where do you -- do you think like high $3.80 for margin is sustainable for the second half of '23 or something below that? I think if we can, given the value of our deposit franchise and I think our proven ability to manage those costs efficiently, that is -- the goal is that we'd be able to maintain a margin in that high $3.80 range despite continuing to price up deposits where needed. Okay. That's helpful. And then curious here with the CEO change kind of what is your internal thought process on M&A activity going forward here? And any color you can give around the discussion level in the market these days? So here very much still interested in M&A opportunities, and I am CEO for the other what, 10 days. So if I get a call, I will certainly respond to that. And one of the first orders of business with Jeff will be sort of outlined to him sort of our incredible past history here, our success, why we've been successful. And I have a high degree of confidence that he's going to be receptive as well. In terms of what's going on in the marketplace, I mean it's one of these things that you have your list -- you have a list, you have all the candidates and every once in a while, somebody raises their hand and says, okay, I want to talk. And it's -- given the number of banks that are -- have dwindled, I -- sort of more of a random event these days than any sort of continuous flow. But I will make the very bold prediction that over time, it will continue. Just hoping we could start over with credit. Can you just remind us, the C&I loan that's in non-performers? What is the actual net number now, net of that $14 million reserve? And then within your loan loss provisioning this quarter, did you take anything? In other words, the $5.5 million, did you take anything specific to that loan? Yeah. So it's about a $23 million outstanding balance. So our exposure on the books, you could say, is about $9 million, given the specific reserve we've allocated. So that primarily was the driver of the $5.5 million provision, Laurie, is that one credit. We allocated money through our pooled approach in the third quarter, specific to that loan. So the $5.5 million provision recorded in the fourth quarter was to get the total allocation up to the $14 million I referenced. Got it. Okay. So just to make sure that I'm hearing that right, Mark. So the $5.5 million that you provided this quarter, that was entirely related to the C&I loan. Got it. Okay. And then on your guidance, I just want to make sure that I'm thinking about this the right way. Your full year 2023 non-interest expense guidance expected to be mid to high-single digits relative to 2022. Are you stripping out the $7.1 million of merger charges from your '22 base? Are you including that in that number? Perfect. And then same thing with the 2023. Are you stripping out CEO search expenses or how do we think about that? Those are embedded in that guidance as well. There's certainly one-time in nature. There's some transition expenses associated with that, that will be one-time in nature, but we are including that in the expense guidance we've provided. Okay. Great. And then last question, and I saved this for last. I don't want to get choked up, Chris. I'm really going to miss you. Your whole team is obviously amazing. We appreciate how clear and transparent you've been with us over the years. Yeah. I just -- I think you're amazing and congratulations, Chris, we're going to miss you. But I guess the big question that I'm just trying to understand, you are involved in absolutely everything, you sit on so many boards, you are the largest insider holder in terms of stock. And you're younger than some of the Board members, and the Street absolutely loves you. Why not stay on the board? Can you help us think about that a little bit? And I realize I'm putting you on the spot. My last question is you're on this earnings call, but just really want to understand it. You are so well loved, that showed up in your price premium for so many years. And I just want to understand why you're not staying involved. Thank you. Yeah. Well, Laurie. Now you and I go way back. I think you were in the very first analyst I met back in 2003. I went to many of your gatherings at which I met many other fellow CEOs, and you helped me get established and understand what the market is all about. And for that, I'm very appreciative. And I'm also extraordinarily complemented with your question. The -- I mean, you've seen a lot. You see a lot of banks and to may -- ask this question makes me feel very gratified that we've done a good job over the years. But to answer your question specifically, I'm taking a page out of my predecessor's playbook. He was a great CEO, too. He saved the bank. I mean, he -- this bank was -- we would not be having this conversation today if it wasn't for Doug Phillipson. He recapitalized the bank, he brought an amazing set of talent in here, and he really set in place, the momentum and the bones upon which this management team has built the bank over the last 20 years. And one of the things I really appreciated about Doug, is that he was there for me. Any time I needed some clarification or a question, he was more than happy. But in terms of setting sort of a new energy, a direction and sort of amping up and the emphasis that I brought to the table, whether it was in the wealth management space, how to think about ramping up the retail space, home equity, some of the technology stuff, he stayed out of my way. I mean and he was not in the boardroom where directors quite frankly, I think, given his reputation would be looking at him every time I said something and just sort of saying, well, Doug, what do you think about this? And I think I need to do that same thing for Jeff. I will be available. Technically -- I mean, literally available for the rest of the year. But after that, I do have relationships and whether it's -- I can -- and I still will, despite not being on contract or in payroll, will be representing Rockland Trust in the marketplace with my community activities, the association of Chris Oddleifson and Rockland Trust is still going to be there. And lastly, Laurie, from a personal perspective, I want more time to do some other things. I'm 65 -- will be 65. I figure I have another 20 years of activeness. My wife and I are planning sort of the -- of ranking the activities with respect to how much physical activity is required. So maybe we'll visit the lou (ph) when we're in wheelchairs. But there are other things, I'm visiting Machu Picchu or require some having some athleticism, I think maybe we'll do early on. So I'm looking forward to that aspect, too, Laurie. But thank you very much. Good morning and congratulations, Chris on your retirement and incredibly successful and consistent track record here over the past 20 years. So I wanted to start off on capital levels, which remain robust and increase this quarter. No share repurchases, it seems like during the quarter, but you still have an authorization outstanding here. How are you guys thinking about the utilization of the share repurchases going forward given that balance sheet growth appears to be more muted in 2023? Yes. Great question, and I think we always answer this question pretty consistently and that is, the share repurchase plan is in place to be opportunistic. We're very comfortable with our capital levels. This gives us a lever we can pull in the event, the economics and the situation on hand makes sense to. So we always think about share repurchase activity as being the right decision for value for our shareholders. We only execute at prices that we feel represent a fair price and given our historical track record and would give us a tangible book earn back period that we are comfortable with in terms of that immediate dilution of buying back. So we typically don't talk to what that exact number is, but that is constantly in the analysis that we performed throughout the year is to gauge what is the right level that we're comfortable with, and it's there in place if the stock price does come under some pressure, and we think it's appropriate to buyback at levels. So we're happy, it's there. It gives us plenty of flexibility moving forward. Got it. I mean the share price is relatively similar to where you guys were doing repurchases in 2Q and 3Q? Have there been any repurchase activity so far in the new year? Okay. Got it. And switching over to loan growth, the pipelines, it seems like, although down a little bit quarter-over-quarter, it seemed to be a relatively strong or similar levels to where they were in the past quarter. And you're talking about in the prepared comments a little bit about less CRE payoffs coming up for 2023. So putting that together, can you talk a little bit about the first quarter and how you see the cadence of loan growth progressing throughout the year? Yeah. I think our expectation is, there's so much uncertainty in the environment. We really are looking at it, only three months to six months out at a time. And I think you referenced to the approved pipeline here at year-end, it's down a bit from where we were in the fourth quarter, but not material. And you saw the results in the fourth quarter with the growth we experienced across most of the commercial books. So we think it's -- we're very positive about the opportunity. Certainly, the rate environment is helping in terms of seeing some reduced level of payoffs. There are some credits out there that we think may still exit and may be in the process of being refinanced. But for the most part, that activity has subsided pretty meaningfully. So I think even with a more cautious approach to new deals given the uncertainty in the environment, the lift we're getting from the reduced payoffs, we think translates to some level of modest growth as we noted in our guidance. Okay. Got it. And as far as cash levels, I know it'd be bouncing around depending on deposit flows, but is there a minimum level of kind of overall cash that you guys want to retain on balance sheet over the long term? No. When we look at liquidity balances as a whole, Chris, and comfortable with absolute levels of liquidity, whether that's cash or other short-term investments. So there isn't a specific cash number that we're targeting. Just a reminder, we have zero wholesale borrowings on the balance sheet today. So we have plenty of access to off-balance sheet liquidity. We have different avenues we could go down when and if that need arises. So we're comfortable borrowing overnight. We're comfortable extending into longer-term borrowings if pressure on cash subsides. So we think we're very well positioned to just take that. And as it comes over the first three months to six months, certainly monitoring our deposit outflow will be a big driver as to any decisions we make on any long-term financing. But at this point, I think it's still very fluid that you'll likely see at least in the first quarter, some level of cash and/or overnight borrowings if that situation arises. This concludes our question-and-answer session. I would like to turn the conference back over to Chris Oddleifson for any closing remarks. Please go ahead. Yeah. Thank you very much, everybody, for joining us today. And for 20 years, I said, I'll see you and talk to you in three months. That's not the case. It's been a real pleasure being on these calls, all these years, and thank you for your interest and support, and I wish you very well. Goodbye.
EarningCall_1450
Good morning, ladies and gentlemen. Welcome to the Fourth Quarter Results Teleconference for Travelers. [Operator Instructions] As a reminder, this conference is being recorded January 24, 2023. At this time, I would like to turn the conference over to Ms. Abbe Goldstein, Senior Vice President of Investor Relations. Ms. Goldstein, you may begin. Thank you. Good morning and welcome to Travelers’ discussion of our fourth quarter 2022 results. We released our press release, financial supplement and webcast presentation earlier this morning. All of these materials can be found on our website at travelers.com under the Investors section. Speaking today will be Alan Schnitzer, Chairman and CEO; Dan Frey, Chief Financial Officer; and our three segment Presidents: Greg Toczydlowski of Business Insurance; Jeff Klenk of Bond & Specialty Insurance; and Michael Klein of Personal Insurance. They will discuss the financial results of our business and the current market environment. They will refer to the webcast presentation as they go through prepared remarks, and then we will take your questions. Before I turn the call over to Alan, I’d like to draw your attention to the explanatory note included at the end of the webcast presentation. Our presentation today includes forward-looking statements. The company cautions investors that any forward-looking statement involves risks and uncertainties and is not a guarantee of future performance. Actual results may differ materially from those expressed or implied in the forward-looking statements due to a variety of factors. These factors are described under forward-looking statements in our earnings press release and in our most recent 10-Q and 10-K filed with the SEC. We do not undertake any obligation to update forward-looking statements. Also in our remarks or responses to questions, we may mention some non-GAAP financial measures. Reconciliations are included in our recent earnings press release, financial supplement and other materials available in the Investors section on our website. Thank you, Abbie. Good morning, everyone and thank you for joining us today. We are pleased to report this morning a solid bottom line for the quarter, exceptional results in our commercial businesses, with higher full year core income and another quarter of attractive margins and strong growth, continued progress addressing the industry-wide loss pressures impacting the Personal Insurance business. Very strong production in all three of our business segments, resulting in consolidated net written premium growth of 10% for the quarter and another quarter of successful execution on the number of important strategic initiatives. Core income for the quarter was $810 million or $3.40 per diluted share, generating core return on equity of 12.3%. These results include $362 million of after-tax catastrophe losses. Core income benefited from record net earned premiums of $8.8 billion, up 10% compared to the prior year period. Our solid underlying combined ratio of 91.4% reflects very strong performance in both of our commercial segments. Looking at the two commercial segments together, the aggregate BI/BSI underlying combined ratio was an excellent 88.3% for the quarter. You will hear from Michael shortly about the progress we are making in Personal Insurance and the roadmap to improve profitability. For the full year, core income of $3 billion or $12.42 per diluted share benefited from higher core income in our commercial segments that was driven by record net earned premiums and strong profitability, including our best ever underlying combined ratio in Business Insurance. Our underwriting and investment results, together with our strong balance sheet enabled us to return nearly $3 billion of excess capital to shareholders, including more than $2 billion of share repurchases. At the same time, we grew adjusted book value per share and made important investments in our business. Turning to the top line, thanks once again to excellent execution by our colleagues in the field and the strong franchise value we offer to our customers and distribution partners. We grew net written premiums by 10% this quarter to $8.8 billion with all three segments contributing. In Business Insurance, net written premiums grew by 11% to $4.4 billion. Renewal premium change remained very strong at an historically high 10.1%. In the property line, which has received a lot of attention post-Ian, renewal premium change accelerated month-by-month in the quarter. Even with continued strong pricing across the board, retention in BI reached a record high 88%. As you have heard us say before, strong retention is a sign of a stable and rational pricing environment. New business in the segment of $558 million increased 10% from the prior year period. Given the attractive returns in the segment, we are pleased with the very strong retention of our high-quality book of business and the strong level of new business. In Bond & Specialty Insurance, net written premiums increased by 5% on a constant currency basis, driven by excellent production in our market leading surety business, where net written premiums were up 18%. Production was also strong in our management liability business, with renewal premium change of 6.3%, retention of 90% and new business, up 23% from a year ago. In Personal Insurance, top line growth was driven by higher pricing. Renewal premium change was meaningfully higher both year-over-year and sequentially as we continue to address the industry-wide loss pressure. Renewal premium change alone contributed more than $1 billion of written premium to our portfolio over the past year. With another quarter of impressive production in each of our segments, we feel very well positioned for the new year. You will hear more shortly from Greg, Jeff and Michael about our segment results. Our 2022 results cap off a decade of strong and consistent performance. We posted a double-digit return on equity in every year over the last decade with the exception of 2017, a difficult cat year for the industry in which we posted a 9% ROE. In every one of those years, we comfortably covered our cost of equity. And over the last 6 years, we have significantly increased our rate of top line growth. We have accomplished all of this with industry low volatility. Successfully investing in differentiating capabilities has been a significant focus for us and an important contributor to our success. As you can see on Slide 24, over the past 5 years, we have meaningfully increased our overall technology spend. At the same time, through our strategic focus on productivity and efficiency, we have significantly reduced our expense ratio. In addition, we have improved the mix of our technology spend, increasing our spending on strategic initiatives by nearly 70%, while holding routine, but necessary expenditures about flat. The consistency of our results also benefits from the diversification of our business across our three segments. If we look back at the combined ratio over the last 10 years, in 5 of those years, Personal Insurance outperformed business insurance. In the other 5 years, Business Insurance outperformed personal insurance. And our Bond & Specialty business delivered spectacular results in every one of those years. The depth and breadth of our diversified businesses is a key advantage and would be very difficult to replicate. Speaking of our business profile, given the economic instability and geopolitical risk around the world, we feel very good about our concentration in North America, the largest, most advanced and most stable economy in the world, where we have the pole position and plenty of room to grow. With uncertain economic conditions ahead, I will also note we have a strong track record of performance through a variety of challenging environments over many years. We have got the experience, the know-how and the capabilities along with an efficient operating model and a rock solid balance sheet to manage through whatever comes our way. To sum things up, I am grateful to my more than 30,000 colleagues for all they have accomplished this year and over time. Given our strong foundation, our track record of successful innovation and our ambitious roadmap, we are very confident in the outlook for Travelers. Thank you, Alan. Core income for the fourth quarter was $810 million, a very strong result considering the significant impact of cat 73, the winter storm that occurred in late December. Core income for the full year was $3 billion. For the quarter, core return on equity was 12.3%, including the 5.9 percentage point adverse impact of cat 73. For the full year, core ROE was 11.3%. As you heard from Alan, our consistently strong performance has delivered double-digit core ROE in 9 of the past 10 years, averaging 12.6% over that timeframe and our adjusted book value per share has nearly doubled over the past decade. For the quarter, underlying underwriting income of $723 million pre-tax reflected higher levels of earned premium in all three segments and a consolidated underlying combined ratio of 91.4%. Terrific underlying combined ratios in both Business Insurance and Bond & Specialty were offset by results in Personal Insurance. Results in all three segments reflected the benefit of earned price that exceeded loss trend. One additional comment on underlying underwriting income. Prior to 2020, the highest level of full year underlying underwriting income we had ever reported was $1.5 billion after-tax. Despite the significant adverse impact of elevated inflation on profitability in Personal Insurance, 2022 marks the third consecutive year with underlying underwriting income above $2 billion after tax. Simply put, our increased premium volumes and diversified portfolio of businesses are generating underwriting profit dollars at a completely different level than where we were just a few years ago. The fourth quarter expense ratio of 27.9% brings the full year expense ratio of 28.5%, our lowest full year expense ratio ever. As we have discussed previously, the improvement in the expense ratio has not been achieved through cutting corners or artificially managing expenses for the short-term. Rather, we have made and continue to make significant investments in technology and other strategic initiatives that we believe will drive our continued success. Our ongoing focus on productivity and efficiency has improved our operating leverage. Looking ahead to 2023, we are very comfortable with an expected full year expense ratio in the range of 28.5% to 29%. Our fourth quarter cat losses were $459 million pre-tax. Activity in the quarter was driven by $512 million from the large winter storm in late December, which impacted most of the U.S. as well as Canada while our losses from this event were significant, but were not outsized relative to our modeled estimates for a storm of this size and intensity. Turning to prior year reserve development, we had net favorable development of $185 million pre-tax on a consolidated basis. In Business Insurance, net favorable PYD of $127 million was driven by better-than-expected loss experience in workers’ comp across multiple accident years, partially offset by increased loss estimates for general liability coverages, primarily umbrella, where year-over-year inflation has resulted in more losses reaching excess layers of coverage. The Bond & Specialty segment saw a net favorable development of $51 million, while in Personal Insurance we recorded net favorable PYD of $7 million. After-tax net investment income of $531 million reflected another quarter of improving returns and higher invested assets in the fixed income portfolio and modest returns in the alternative portfolio, which we expected given the downturn in the broader equity markets that occurred during the third quarter. Looking forward to 2023, we expect after-tax fixed income NII, including earnings from short-term securities to average above $535 million per quarter with an estimated $515 million in Q1, growing to an estimated $560 million in Q4. Page 21 of the webcast presentation provides information about our January 1 cat treaty renewals. Our longstanding corporate cat XOL treaty continues to provide coverage for both single cat events and the aggregation of losses from multiple cat events. Consistent with the increase in our annual net written premium volume for property, we increased our retention level to $3.5 billion from the prior $3 billion level. The treaty provides 100% coverage for the $2 billion layer above the $3.5 billion dollar retention. The per occurrence loss deductible remains unchanged at $100 million. We did not renew the underlying property aggregate catastrophe XOL treaty, which was only 45% placed in 2022. As we have said previously, we believe that hardening a reinsurance market provides a relative advantage for Travelers. Our consistently strong underwriting results give us an advantage in terms of reinsurance pricing and capacity. That, combined with the fact that we buy less reinsurance than most of our peers, gives us a cost of good sold advantage. We can let that fall to the bottom line or reflected in pricing without compromising our return objectives, making us more competitive for attractive new business opportunities. Overall, while property reinsurance pricing was higher when we consider the level of price increase as well as changes in terms and conditions we are obtaining on our direct written business, we do not expect a noticeable impact on our net underlying loss ratio for property. Also related to the overall reinsurance market as well as the E&S market, you will recall that in 2021 we took a minority ownership stake in Fidelis. Effective January 1, 2023, we have separately entered into an agreement with Fidelis, whereby Travelers will take a 20% quota share on policies issued by Fidelis with effective dates in 2023. The market for Fidelis products is probably as favorable as it has been in 20 years or so and the market was impacted by 9/11, dot-com collapse and Hurricane Katrina. This quota share arrangement allows us to participate in the hard market, while also accelerating our understanding of this marketplace. While strategically valuable and expected to be accretive to earnings, the quota share deal is not expected to have a significant impact on our consolidated financial results. Our portion of net written premiums from Fidelis is expected to be around $550 million to $600 million for the full year and those premiums will be reflected within the international results of Business Insurance. Detailed terms of the quota share have not been disclosed, but we can share that there is a loss ratio cap to ensure that even a worst case underwriting scenario is boxed to a very manageable impact on Travelers. Turning to capital management. Operating cash flow for the quarter of $1.3 billion was again very strong. All our capital ratios were at or better than target levels and we ended the quarter with holding company liquidity of approximately $1.5 billion. For the full year, operating cash flow was once again very strong at $6.5 billion, reflecting the benefit of continued increases in premium volume, strong profitability and paid losses that for the full year were once again less than 90% of incurred losses. As we have said previously, we are assuming that this lower level of payment activity is ultimately a timing issue. In establishing our reserves and pricing our products, we assume that elevated severity related to social inflation has not abated at all. Our substantial cash flows give us the flexibility to continue to make important investments in our business, return excess capital to our shareholders and grow our investment portfolio, which increased to $86.7 billion, excluding net unrealized losses at year end. Interest rates increased slightly during the fourth quarter, but spreads narrowed. And accordingly, our net unrealized investment loss decreased from $6.3 billion after tax as of September 30 to $4.9 billion after tax at year-end. Adjusted book value per share, which excludes unrealized investment gains and losses, was $114 at year-end, up 4% from a year ago. We returned $721 million of capital to our shareholders this quarter, comprising dividends of $220 million and share repurchases of $501 million. For the year, we returned $2.9 billion of capital to shareholders, including $2.1 billion of share repurchases. Overall, we had another very good year with strong top line growth in all three business segments, excellent and improved margins in our commercial businesses, our best ever expense ratio and a very strong balance sheet that has us well positioned for whatever economic conditions the future may bring. Thanks, Dan. Business Insurance had another strong quarter rounding on a terrific year in terms of financial results, execution in the marketplace and progress on our strategic initiatives. We are firing on all cylinders. Segment income for the quarter was $725 million with an all-in combined ratio of 89.5%, both great results. We are once again particularly pleased with our exceptional underlying combined ratio, which was also 89.5%, an all-time best fourth quarter result. The underlying loss ratio increased by a little more than 0.5 point as the benefit of earned pricing was more than offset by the comparison to the prior year quarter, which benefited from both a particularly low level of property losses and the favorable impact associated with the pandemic. The increase in the underlying loss ratio was more than offset by a lower expense ratio that benefited from our ongoing strategic focus on productivity and efficiency. Net written premiums for the quarter were up 11% from the prior year quarter to a fourth quarter record of $4.4 billion, benefiting from strong renewal premium change, high retention and an increase in new business levels. Turning to domestic production for the quarter, renewal premium change was once again historically high at 10.1%, with renewal rate change of 4.5% and record growth in exposure. Retention reached an all-time high at 88%. New business of $558 million was the strongest fourth quarter we have ever produced. At the product level, in addition to what you heard from Alan about pricing in the property line, terms and conditions and the line tightened over the course of the quarter, further improving the price per unit of risk. While not reflected in our production metrics, this improvement in the price per unit of risk will contribute to our profitability over time. In workers’ comp, renewal rate change was a little more negative than we have seen in recent quarters, which is a reflection of the strong profitability in the line and the benefit of continued strong exposure growth. Overall, workers’ comp renewal premium change was positive in the mid single-digit range and actually a little higher year-over-year. We are pleased with these strong production results and the excellent execution by our colleagues in the field. Given our high-quality book as well as several years of segmented rate increases, together with improvements in terms and conditions, we’re thrilled to continue to achieve this historically strong retention levels. The pricing gains we achieved in the quarter reflect our deliberate execution, which balanced the persistent headwinds and uncertainty in the current environment with the improvement in profitability across our portfolio after several years of strong pricing. As always, we will continue to execute our granular pricing, careful management of deductibles, attachment points, limits, sublimits and exclusions to maintain profitable growth. As for the individual businesses, in select, both renewal premium change of 10.8% and retention of 83% were strong. New business was up 6% from the prior year quarter, driven primarily by the continued success of our BOP 2.0 product as well as growth in other lines. We’re pleased with the progress we’ve made in improving the profitability of this business over the last couple of years, while continuing to invest for future growth. In middle market, renewal premium change remained historically strong at 8.8%, while retention of 91% reached an all-time best. New business was up 13% from the prior year quarter. As for full year results, segment income of more than $2.5 billion was exceptional, benefiting from record earned premium in our best-ever underlying combined ratio. In addition, the top line of $17.6 billion and full year retention were both record highs, while new business premiums were near an all-time high. These results were driven by the successful execution of our thoughtful and deliberate strategies. And while delivering these financial and production results, we’ve also continued to invest in strategic capabilities that will enhance our many competitive advantages, designed to enable us to continue delivering profitable growth over time. For example, during the year, we advanced our already state-of-the-art product and service capabilities by continuing to roll out our BOP 2.0 product, which is now live in 46 states as well as launching our new commercial auto product in a handful of states. Both products contain industry-leading segmentation. In addition, we continue to make progress on developing industry-leading user experience capabilities to make it easier and more efficient for our distribution partners and customers to do business with us. In particular, in our middle market business, we advanced our capabilities around digitizing the underwriting transaction for our agents and brokers. And in our Small Commercial segment, we launched our new front-end rate quote and issue interface platform to make it faster and easier for our agents to write business with us, all while maintaining the underwriting discipline and specialization behind the scenes. And finally, we continued to improve our operating leverage through our relentless focus on productivity and efficiency, as I referenced earlier. I’ll note that our full year expense ratio of 29.7% is down more than 2.5 points from the 2016 level. We’re proud of these results and the team that produce them. Thanks, Greg. Bond & Specialty ended a terrific 2022 with another great quarter on both the top and bottom lines. Segment income was $221 million, up 30% from the prior year quarter, driven by strong and higher earned premium and an exceptionally strong combined ratio, which benefited from a higher level of net favorable prior year reserve development. The underlying combined ratio was also strong and improved about 1.5 points from the prior year quarter to a terrific 81.7%, driven by the benefit of earned pricing. Turning to the top line. Net written premiums grew 5%, excluding the impact of changes in foreign exchange rates. Domestic Surety grew an outstanding 18% in the quarter, driven by an increase in the number of bonds issued and higher average bond premiums. In domestic management liability. Given the strong returns, we’re very pleased that we increased retention of point from last quarter to a near record 90%. That’s a 4-point improvement from the prior year quarter. Renewal premium change was solid at 6.3%, and we’re also pleased that we increased new business 23% from the prior year quarter. Excluding FX, net written premium in our international business contracted modestly from the exceptionally strong fourth quarter of 2021, primarily due to the impact of the significant decline in merger and acquisition activity on our transactional liability book of business. For the full year, Bond & Specialty produced record earned premiums and an outstanding combined ratio of 75.3%, driving segment income above $900 million for the first time ever. So for both the quarter and year, our results were terrific, driven by excellent execution, returns from our ongoing strategic investments in our competitive advantages and the market-leading value proposition that we offer our customers and distribution partners. Thanks, Jeff, and good morning, everyone. In Personal Insurance, the fourth quarter loss of $61 million and a combined ratio of 105.3% were negatively impacted by the weather event in late December as well as elevated underlying loss activity in both automobile and homeowners and other. While our results aren’t meeting our target returns, we are encouraged by our strong marketplace execution as we continue to respond to the loss environment with both increased pricing and non-rate actions. Net written premiums for the quarter grew 13%, driven by double-digit renewal premium change in both domestic automobile and homeowners, reflecting our focus on improving profitability. In automobile, the fourth quarter combined ratio was 111.4%. As a reminder, while there is some seasonality in auto every quarter, the fourth quarter typically has an elevated loss ratio driven by things like holiday driving in Northeast winter weather. Over the last 10 years, the fourth quarter underlying loss ratio has been approximately 6 to 7 points above the average for the first three quarters. Seasonality aside, the underlying combined ratio of 110.5% increased 6.7 points from the fourth quarter of 2021, primarily related to the continued inflationary impact on vehicle replacement and repair costs, as well as increased claim frequency, which returns to pre-pandemic levels in the quarter and higher bodily injury severity. These loss impacts were partially offset by the growing benefit of earned pricing and a 1-point reduction in the expense ratio. Separately, the current quarter results included a modest impact for the reestimation of prior quarters. We continue to factor our latest view of loss experience into our pricing actions going forward. In Homeowners and Other, the fourth quarter combined ratio was 99.4%. This was 21.6 points higher relative to the prior year quarter, driven by catastrophe losses that were 13 points, 2 points higher than the prior year period and a higher underlying combined ratio. The underlying combined ratio of 82.2% increased 8.8 points. This increase was primarily driven by higher loss severity related to continued labor and material price increases as well as higher non-catastrophe weather losses. This loss pressure was partially offset by the current quarter benefit of earned pricing. Turning to production. Quarterly results reflect our rate and non-rate actions as we seek to manage growth and improve profitability. In domestic automobile, retention moderated this quarter as renewal premium change increased 3 points from the third quarter to 11.4%. New business written premiums declined 3% prior to the prior year compared to the prior year, and policies in force were essentially flat with last quarter as our additional rate and non-rate actions are taking effect. In domestic homeowners and other, we achieved renewal premium change of 14.5% in the fourth quarter. The retention remained strong at 84%. Slide 17 provides a graphical representation of renewal premium change in domestic automobile and homeowners and other. We added this view to highlight our progress with respect to renewal premium change over the last several quarters. The magnitude and speed of our pricing actions simultaneously across both lines of business is significant. As Alan mentioned, we have added over $1 billion of written premium to our portfolio in 2022 as a result of the high levels of renewal premium change. The benefits of this increased pricing will continue to earn into our results over time. Looking ahead to 2023, renewal premium change in both lines of business will increase above these already very strong levels as we continue to take action to improve profitability. Consistent with our comments last quarter, we expect written pricing in auto to be adequate in states representing the majority of our business by midyear 2023. In 2022, our team met a challenging environment head-on and took action to address rising costs. We are confident that the actions we have taken and will continue to take will drive improved profitability as we move through 2023 and beyond. Good morning, everyone. It’s Greg Peters. I guess I’ll start with the first question on Business Insurance and the growth. You produced some outstanding results in all of your segments and for ‘22. And there is a bunch of factors that we’re considering as we think about the outlook for ‘23 and ‘24. We’re watching, obviously, as you are the renewal premium change. We’re also watching the rate change on renewals. And I’m curious, when you look about – when you think about ‘23, what are some of the factors that you think might influence your top line results in Business Insurance? Yes, Greg, good morning. And thank you for the question. Let me just go back to basics and just talk about how we approach this business because we don’t approach it with a grower shrink mentality, we approach it with an overall approach to the marketplace. So we look at our business and we want to keep our best business, and you can see our retention this quarter was off the charts, which is a reflection of how we feel about that book of business. We want to improve the returns on the business that need it, and so we want to execute at a very granular, very thoughtful, very strategic level in terms of price and rate in RPC and then by investing in franchise value and through a lot of hustle in the marketplace. We want to make sure that we’re generating attractive new business opportunities. And we’re going to – we did that in ‘22 and the results have been fantastic. We’re going to do it again in ‘23, and we’re very confident about that. And let me spend just a second on the pricing environment because that seemed like it was part of your question, and I’ve seen a number of you write about it this morning. So I think it’s hard to characterize this pricing environment as anything other than very strong. At 10.1% that RPC is spot on an eight-quarter average. So incredibly stable and near record levels. Small movements between pure rate and exposure, but I would emphasize small movements between rate and exposure. The breadth of the pricing gains across our book is very strong and very consistent. I don’t think you can assess the pricing environment without looking at retention and given where that is literally record levels and given the profitability very strong. The pricing gains that we achieved were broad-based, led by property, auto, umbrella and CMP. And then you take all that against the margins that we printed and we just – we feel fantastic about the pricing and the overall execution this year. And again, we’re going to go out and do it again in ‘23. Just a point in your answer, you mentioned the renewal premium change. Can you talk about your perspective on what’s going on with the renewal rate change, which seems to be trending down? Yes. Again, we’re executing at a very granular level, looking at what it is we need to do by account. And you look at that 10.1% overall renewal premium change, very strong near-record levels. And the fact that there is a little bit of movement back and forth between rate and exposure to us almost inconsequential. So you can look at that 0.5 point of change in isolation and try to make something out of it. We look at the overall production picture, and it just looks fantastic. So – and again, Greg made a really important comment in his remarks, which is we’re – the execution you see is balancing a bunch of things going on. On the one hand, there is headwinds and some uncertainty. We’ve got inflation in the marketplace, supply chain is – hasn’t returned to pre-pandemic levels. We’ve got weather volatility. We’ve got reinsurance. We’ve got social inflation we’ve talked about over the years. So on the one hand, that continues to be a headwind for us, and we take that into account. But on the other hand, we’ve got a bunch of years of very strong pricing and look at where the margins are today. So the rate change of 4.5% and the overall RPC doesn’t happen to us. That’s a very deliberate execution on our part, taking into account everything that we see in front of us. Great. And just the last clarification point, you talked about the inflation factors. And I think in the comments, you mentioned there are some issues in umbrella, minor issues. What’s your view on inflation trends as it might affect the reserve levels for ‘23 relative to what your assumptions may have been last year? That’s it. Hey, Greg, it’s Dan. So I don’t think anything terribly surprising. And I guess I’d step back and look at reserve development over the course of 2022 and say, full year number, $650 million of favorable reserve development. Of course, there are some lines that are going to develop a little better and some that are going to develop a little worse. But $50 million over the course of the year, favorable development in all three segments of the business. Umbrella, not really different than our overall thesis, but sort of the degree to which severity moved was a little more than we expected. So as we usually do, we’re trying to look at the data as quickly as possible and react as quickly as possible and all of that inside of a net favorable PYD. So we’re feeling very good about where the balance sheet is. Hey, thanks. First question, just around the excess capital position. Historically, the company has been able to easily return operating earnings and in some years, even more than debt of shareholders. We’ve never seen this level of first of all, exposure growth and also just seeing the retention go up on the property cat treaty. Are we at a point yet where I guess the growth and the risk of the business could start to impact capital return decisions? Hey, Ryan. Good morning. It’s Dan. Yes, look, I think we’ve talked even a couple of years ago about the fact that we were seeing an increase in the level of top line growth. We knew we were going to need to hold more capital to reflect both a bigger top line book of business, which brings with it a higher level of reserves on the balance sheet. And so we said at that time, we don’t expect us to continue to be able to return nearly 100% in terms of operating earnings between buybacks and dividends. I think what you see in 2022, in particular, is the fact that we had a good strong capital position coming out of 2021. Remember, earnings in the fourth quarter of last year were tremendously strong. So we probably exited last year with a little more capital than we might have forecasted we were going to end the year. So what we’re doing in 2022 with capital management and as we go into ‘23 is considering all the things that you just said, that continued outlook for top line growth, where the balance sheet is from a reserve perspective, what our reinsurance programs are and what our property exposures look like. And we were very comfortable returning what we just did in the fourth quarter. Got it. And then a follow-up for Michael, just thinking about the rate you are taking on the homes side, is there a way to kind of compartmentalize that in terms of how much of the rate is toward attritional type losses versus how much is budgeting for higher caps? I am not sure if there is, but I would be curious if you had any perspective on that? Sure, Ryan. Thanks for the question. I would say, broadly speaking, it’s sort of hard to compartmentalize because the majority of the rate we are taking is base rate. Now again, the numbers that we give you are renewal premium change. So, just to clarify, right, renewal premium change is rate and values, and we have talked about the fact that the RPC numbers that you see certainly include both. And our outlook for 2023, where we indicate that renewal premium change is going to go north from here, is driven by further increases in both rate and values. But in terms of attritional loss versus cat loss, again, it’s fairly broad-based rate across the book. So, there is not really a significant differentiation there. Thanks. Good morning. Michael or actually, Dan, sorry about that. Dan, could you just elaborate a little bit more on the financial impacts of non-renewing the aggregate reinsurance outside of a higher potential catastrophe load? I think when you put it on, there was a 50 basis point headwind to the underlying combined ratio, which obviously was offset by lower cat load, but that was back in 2019, so I am sure it’s changed. It doesn’t sound like you expect a noticeable impact on the property loss ratio or the total company expense ratio. So, just wondering if you could just sort of talk through the puts and takes of non-renewing that aggregate? Sure, David. So, a couple of things, in 2022, we did not attach the treaty, right. So, we didn’t hit the underlying, so it didn’t have any beneficial impact in 2022’s results. You are right that when we first entered into the treaty, which was at the beginning of 2019, we said at the time that the impact of the incremental ceded premium from that treaty was going to have about 0.5 point adverse impact on underlying results because of the impact on the denominator. In 2019, we told you that we placed – it’s the same $500 million layer in all 4 years. In 2019, we have told you that we placed 85% of the layer in 2022. We only placed 45% of the layer. So, in sort of broad sweeping terms, you could expect that the absence – the impact in 2022 on the underlying would have been about half as much as it was in 2019. And so that’s what the year-over-year comparison will look like in 2023. So, maybe somewhere around 0.25 of a point. Got it. And then just following up on that, is that something and you also mentioned just the relative cost of goods sold advantage from buying less reinsurance. Does that benefit something you are looking to price or just allow to flow through in pricing as opposed to falling to the bottom line just based on your commentary, it sounds like that might be the case, but maybe elaborate on that as well. Yes. I don’t think it’s really big enough to impact the way we think about the pricing on the property book overall. I mean – so again, we placed 45% of the $500 million layer. We didn’t attach it. If you look across the business, we have got $8 billion or $9 billion worth of property premium. It goes into our consideration of how do we think about pricing in our underwriting appetite. But we said sort of from the first day we bought that treaty and we sort of would have been happy if we bought it or almost as happy if we didn’t buy it, it was sort of on the margin. So, the absence of it is not really going to have any impact on the way we view pricing adequacy and property. Got it. Thank you. And then coming back to Michael, just wondering, I think in the past, I have heard you guys talk about mid-90s combined ratio in auto. And you said you thought you could get to written rate adequacy still by ‘23. Maybe just one, is that still the right combined ratio to think about you guys are targeting? And then any sort of view on timing of when you think you can get there? Sure, David. I think in terms of the target, obviously, it’s impacted by a lot of things. I think we have said mid-90s or even a range on the upper end of the mid-90s is actually, I think what we have talked about historically. Certainly, investment yields are better than they were when we talked about that. But I think broadly speaking, you can think of that range as where we are trying to get to. And again, as I have described last quarter and reiterated this quarter, we think that written pricing will get to adequacy on the majority of the business by midyear. So, again, that’s a leading indicator of what you are going to see in GAAP results, right. So, I have also talked about the price we are taking will earn its way into our results over time. This morning, I have said you will see the benefit sort of throughout ‘23 and beyond. I think what’s important to note is the comment we made this morning about the growing impact of earned rate on the auto results this quarter, that impact will grow through 2023 as we have taken – you see more and more written RPC in the book of business as the year goes forward this year. We have talked about higher levels of written RPC in 2023 that paves the way for increased earned rate impacting the book of business quarter-over-quarter-over-quarter as you go into 2023. So, I think those are the breadcrumbs we are trying to give you in terms of how to lay out your expectations for next year. Obviously, the million-dollar question for everybody in ‘23 is what happens to loss experience and where the loss trends go from here. And that’s the – if you sort of lay out your own view of earned rate versus what’s going to happen to loss trend that will sort of help you figure where you think the lines are going to cross. Hi. Thanks. Good morning. Michael, maybe picking up on your last comment, I mean you say that you guys are going to reach within rate adequacy in personal auto. So, what are you guys assuming for frequency and severity from here when you make that comment? Yes. Elyse, I think we are not going to get into specifics on frequency and severity assumptions for next year. I think what we have talked about pretty consistently is we have been booking to the loss experience that we have seen, those booked trends remain double digit as we talk – as we sit here today, talking about the fourth quarter. And again, we have pretty consistently talked about observing double-digit severity trends in the book. Frankly, that’s a property comment and an auto comment. And is the severity and loss pressure that we are contending with. And we have also said that we have been factoring those increased costs into our expectations, both in terms of the actual experience and our outlook. But I don’t think we are going to put a number on the forecast severity and frequency trends beyond that. Then on the reinsurance program, can you give us a sense of – an absolute sense of how much your reinsurance costs went up? And then on the capital side, as you guys have added more volatility right by retaining additional cat losses in ‘23, how could that affect your capital allocation? What should we expect slower buyback in the second quarter and third quarter? And could this even impact the excess capital that you would have for new business growth? So, a couple of things, Elyse, it’s Dan. We are not going to go into the details of reinsurance pricing. What I was trying to communicate in my comments was when we consider the pricing that we are getting on the direct business that we are writing in our management and terms and conditions. We don’t expect the higher pricing for reinsurance to have much of an impact on our margins. And again, the change in the overall treaty, I don’t think it’s going to have a significant impact on our capital position, I really think of it as sort of business as usual. We made the comment that the attachment employee increase is sort of in line with our increase in property premiums. So, the attachment point went up 16% or 17%. Our premium volume in 2022 compared to 2021 was up 15% or 16% or 17% in both business insurance and personal insurance I don’t think it’s going to have a dramatic impact on – it does not have a significant impact on our view of capital adequacy now. And I don’t think it’s going to have a significant impact on the way you see us behave from a capital perspective in 2023. Thanks. Good morning all. A quick question on, I guess the quota share arrangement. Can you talk about – and I am putting this as binary, and it’s probably not. But can you talk about why Travelers is going through sort of quota share arrangements to capitalize on the hard property market as opposed to your own excess and surplus science paper? Yes. Meyer, it’s we have got all the flexibility in our property business and in our other businesses with E&S paper and otherwise to do whatever it is we want to do. This was an opportunity for us to work a little bit more closely with Fidelis. We think they are interesting in what they do and wanted to understand it a little bit better. And they are in some businesses that we just haven’t historically been in. And so in cases like that, it’s not the only place we have done it. But in cases like that, we look to leverage the capabilities of other talented underwriters and this is just one of those opportunities. Okay. No, that makes sense. And then a quick question for Michael. You talked a little bit about, I think un-quantified the impact of accident year ‘22 loss take increases in the fourth quarter, did that change have a meaningful impact on the indicated rate need? Sure, Meyer. Again, I would say every quarters of additional experience where we see double-digit loss increased experience impacts our rate need, it impacts our loss experience. The good news is it factors into the evidence we have to go to regulators to ask for rate increases. So, it certainly, the additional quarter of sort of double-digit severity did put additional upward pressure on our rate indications and that’s what we are factoring into the indications were taken to the department in early 2023. Hi. Good morning. I had one follow-up on the personal auto. We saw a peer of yours that’s had severity sort of picking up maybe faster than they even were expecting earlier in the year and as well as bodily injury that’s sort of being settled at this point. Just wanted to see, is that something you have looked at harder in your book, how confident are you that you are fully capturing the severity in the way you are reserving on the auto? Do you feel comfortable with where that is headed into 2023 and the starting point here? Sure. This is Michael. Maybe I will start and Dan can speak to the reserving element of it. Certainly, as I talked about the prior period comparison in auto, we are seeing severity across auto physical damage coverages and bodily injury coverages. We have talked about both auto physical damage and bodily injury and either prepared remarks or Q&A sort of throughout the year. We have certainly spent more time talking about auto physical damage, but bodily injury severity trends have been elevated throughout the year. I think we have talked about them being elevated, but consistent with our expectations. They were a little worse in Q4, which is why we call them out. But we have booked to that in our Q4 results. They were also an element of the prior period – current year prior quarter development that I called out in the prepared remarks as well. So, they are in the loss estimates that we booked for the quarter and the full year. Alex, it’s Dan. Just in terms of the balance sheet, I think we made this comment last quarter as well. We were pretty consistent in 2020 and 2021 in saying that we felt we were being appropriately cautious in allowing for the elevated level of uncertainty in the environment at that time when we were making our loss picks, including in personal insurance. And I think that’s continued to proven to hold up. As Michael said, our expectation was always that bodily injury severity, not only was elevated, but the trend slope was upward moving on that. And so I think when you take into consideration the fact that we were sort of intentionally reflecting an elevated level of uncertainty in ‘20 and ‘21 and trying to continuously react to the most recent data as it comes in to this point all the way through the end of 2022, our reserves for prior years have held up just fine. That’s really helpful. Thank you. And then my follow-up is on workers’ comp actually. We were just looking at some of the NCCI stuff out there. I mean it looks like in ‘23, maybe there is a bit more pressure on workers’ comp pricing than even in the recent years. I appreciate though that there is also an improving starting point for ultimate loss ratios just based on the way that the development has been trending. So, when I think about all those things, I mean can you help me think through what that means for accident year loss ratios in ‘23, just at a high level and whether we should be thinking about that as a pressure point? Yes. Alex, let me start, and I will look at Greg, if I missed something here. So, renewal price change was mid-single digits positive, as you heard from Greg. Given the durations of the liability, we take a pretty cautious view on how we think about loss trend and the outlook for that. And so you would say pricing is a little bit positive, you would say loss trends negative. And the net of those two things would probably be a little bit negative as we think about next year. I think the question is going to be what’s loss trend going to do because it has – over the last few years or more than that surprised us to the benign side. And so we will just have to see where the losses come in and then take a look at the calendar year results. But again, I would just say workers’ comp has been a fantastic line for us. And we think the outlook for it is positive as well. Good morning everybody. First question, just going back to the cat load. So, I think we are seeing a non-renewal of the property ad cover, a shift up in XOL retention, maybe some additional cat coming in from Fidelis the quota share as well. How should we think about that kind of in aggregate as we think about 2023, does that essentially mean that we should think about maybe a lower aggregate loss ratio, but maybe some additional volatility? I don’t think that’s where I would go Yaron on that. Tell me what you would look at that would lead you to look for a lower aggregate loss ratio? Well, I would think that more cat-exposed business would have a lower attritional loss ratio coming with it, provide retention rates, we have a lower return on additional loss year as well. Yes. I think you are really talking on the margins. I don’t think we are very – we are significantly changing the mix of the property book we write in terms of what its cat-exposed profile is. Fidelis, again, at those levels and a portion of what they write is going to be cat-exposed. But at that level, that’s going to have a very small impact on our overall base of premiums. We look at the cat results over the last few years. And I think like everyone sort of continually update our view of – and for us, it’s importantly – it’s weather losses, not just what falls into the catastrophe bucket, right, because we have got sort of a more restrictive definition of what cat is than most other folks. But it’s really not a significant change. So, we don’t see a significant change in the relative percentage of the book that’s cat exposed. We don’t see a significant change despite some changes in reinsurance, I would describe those changes in reinsurance relative to the property book as a whole as pretty modest. So, I don’t think it dramatically changes our cat profile. So, I don’t really think it’s going to have a significant impact on the way we think about the property book going forward. Okay. That’s very helpful. And then maybe shifting to Michael’s world, were there any entry year catch-ups in personal auto this quarter? Yes, Yaron, it’s Michael. I think to your question, we did have a modest impact from re-estimation of prior quarters. And I talked about the auto physical damage, the frequency and the bodily injury as the drivers of the period-to-period change. There was really some prior year re-estimation sort of across a number of factors in the book, but again, it was modest. Yes. I mean it was, I would say, about a point, a point or two points kind of – and again, it varied a little bit by coverage, but call it around one point or so. Thank you very much. I appreciate your time this morning. I know there were several people left in queue. So, as usual, please feel free to follow-up after. Thanks so much. Have a good day.
EarningCall_1451
Good morning everyone. And welcome to the Delta Air Lines December Quarter and Full Year 2022 Financial Results Conference Call. My name is Matthew, and I will be your coordinator. At this time, all participants are in a listen-only mode until we conduct a question-and-answer session following the presentation. As a reminder, today’s call is being recorded. [Operator Instructions] Thank you, Matthew, and good morning, everyone. And thanks for joining us for our December quarter and full year 2022 earnings call. Joining us from Atlanta today, our CEO, Ed Bastian; our President, Glen Hauenstein; our CFO, Dan Janki. Ed will open the call with an overview of Delta’s performance and strategy, Glen will provide an update on the revenue environment and Dan will discuss costs in our balance sheet. After the prepared remarks, we will take analyst questions. We ask that you please limit yourself to one question and a follow-up, so we can get to as many as possible. After the analyst Q&A, we will move to our media questions. Today’s discussion contains forward-looking statements that represent our beliefs or expectations about future events. All forward-looking statements involve risks and uncertainties that could cause the actual results to differ materially from the forward-looking statements. Some of the factors that may cause such differences are described in Delta’s SEC filings. We will also discuss non-GAAP financial measures and all results exclude special items unless otherwise noted. You can find a reconciliation of our non-GAAP measures on the Investor Relations page at ir.delta.com. Thank you, Julie. Good morning, everyone. We appreciate you joining us today. Earlier Delta reported our full year results including our December quarter earnings per share of $1.48 on record revenue that was 8% above 2019 levels. We generated a 12% operating margin, our third consecutive quarter of double-digit operating margins pointing to the strength of our recovery. I want to sincerely thank the 90,000 strong Delta team for their outstanding work in delivering these results and serving our customers during a very busy holiday travel season. In my opinion, 2022 was the most difficult operational year in our history and was capped off by severe winter storms over the holidays. I am grateful to our employees for their great work to recover the operation, while keeping our customers and each other safe. They are the reason our brand and customer loyalty is at the top of the industry. Our December quarter earnings per share and margins exceeded guidance, marking a strong close to a year where we made significant progress regarding restoration of our financial foundation. For the full year, we reported earnings of $3.20 per share on $46 billion of revenue. We delivered pre-tax income of $2.7 billion, an improvement of more than $6 billion over 2021. Delta’s profitability led the industry and in our nearly 100-year history, 2022 was our seventh highest result even with a $1 billion loss in the first quarter. We are pleased to report positive free cash flow for the year, which funded $6 billion of capital invested back into the business and we repaid close to $5 billion in gross debt. Sharing our success is a longstanding pillar of Delta’s culture and I am proud to announce that we will be paying our employees $550 million in well-earned profit sharing coming Valentine’s Day. 2022 came in ahead of our plan on revenue, earnings and cash flow, demonstrating strong execution in the first year of the three-year plan we laid out at the 2021 Capital Markets Day. I am incredibly proud of the team for rebuilding the world’s best performing airline, and importantly, we are not just building back, we are continuing to improve and extend our competitive advantages. Delta’s brand continued to strengthen in 2022, with record performance from our loyalty and co-brand card programs, and customer satisfaction scores consistently perform above pre-pandemic levels. Through the year, we have hired and trained 25,000 new employees, now representing over a quarter of the total company. Our team showed their operating talent and resilience as we retained our number one position in completion factor and on time arrivals amongst our peer set, despite having so many new team members. The Delta brand is centered on our safe, reliable and exceptional service, and our operational excellence was recognized by Cirium last week, which named us yet again the most on time airline in North America. We fortified our international partnerships in 2022, position -- positioning us for profitable international growth in the years ahead. As detailed last month, expanding our international margins to domestic levels is an important opportunity for Delta in the years to come. We have invested in the customer experience at every stage of the travel journey, from the continued refresh of our fleet with next-generation far more fuel efficient aircraft to generational airport rebuilds and technology investments that are providing our employees better tools and our customers a more seamless experience. And we continue to attract and partner with leading brands to grow our SkyMiles ecosystem and further enable customers to use their SkyMiles during travel and beyond. Heading into 2023, our momentum continues. At the Consumer Electronics Show in Las Vegas just last week, we unveiled the next phase in our vision to connect the Sky. Starting February 1st, Delta will be the first major U.S. airline to provide fast, free, unlimited WiFi to all through its free SkyMiles account. This will be available on nearly 80% of our U.S. system to start and growing every week. By the end of next year, we expect to deliver this service seamlessly throughout the rest of our international and regional fleets. And we debuted Delta Sync, which will create personalized experiences and engagement opportunities on the free WiFi portal. We are partnering with great brands like T-Mobile and Paramount+, as well as building on our longstanding relationship with American Express to bring to life our vision of a more connected and personalized travel experience. As a trusted consumer brand, Delta continues to differentiate the premium flying experience, building loyalty and supporting our ambition to transcend the industry. Moving to our outlook, at our Investor event last month, we provided full year 2023 guidance for revenue growth of 15% to 20% year-over-year, earnings of $5 per share to $6 per share and free cash flow of over $2 billion. We are affirming that guidance today and introducing our March quarter outlook, which Glen and Dan will provide in detail. For the March quarter, we expect to deliver a 4% to 6% operating margin and improve our pre-tax income by more than $1 billion compared to the same period last year. Importantly, we are embedding the assumed impact of all labor cost increases throughout our guidance metrics. We are pleased to have reached an agreement in principle with our pilots, but out of respect for the process, we will not be discussing the details of the agreement on today’s call. As I outlined last month, I have never seen a more constructive backdrop for the industry. Demand remains strong as passengers return to the skies and industry returns to the long-term trend to GDP, all while supply constraints continue. I believe our industry will see tens of billions of dollars of incremental demand in the next few years coming out of the pandemic. As the industry leader with a proven strategy and strong execution track record, Delta is well positioned to build on our momentum in the New Year. We are confident in our ability to deliver significant improvement in earnings and free cash flow in 2023, consistent with the plan we laid out last month and we are on track to deliver our 2024 targets of more than $7 of earnings per share and $4 billion of free cash flow. As always, we remain mindful of the macroeconomic trends and have demonstrated that we have the tools to effectively manage a changing economic climate. In closing, Delta delivered in 2022, outperforming our plan and leading the industry operationally and financially. We are uniquely positioned to grow earnings and cash flow in 2023, 2024 and beyond. The power of our premium brand continues to grow, and with the very best people in the industry, I couldn’t be more excited about what’s ahead for Delta and our customers. Thank you, Ed, and good morning, everyone. I couldn’t be prouder of what the Delta people accomplished throughout 2022 and I want to congratulate our teams on their much deserved profit sharing payout they will be receiving next month. For the full year, we generated revenue of $46 billion, a $19 billion improvement year-over-year. We delivered record December quarter and full year unit revenues, sustaining our revenue premium to the industry of more than 110%. For the 12th consecutive year, Delta was named the number one corporate airline in Business Travel News survey, as we continue to invest in our network and product offerings. And through the year, we made significant progress on our long-term commercial strategy to deepen our network advantages, expand premium revenues, grow our loyalty ecosystem and further diversify our revenues. Starting with our network strategy, we focused on solidifying our positions in coastal gateways, while protecting our core hub shares. We secured the leading positions in both Boston and Los Angeles, while increasing local market share in our core hubs. Premium let all year with paid load factors higher than 2019 and yield growth outpacing Main Cabin, while basic economy made up less than 5% of revenue, half of the 2019 levels. We expanded our Delta Premium Select rollout during the year. Customer response has been positive and the cabin performed better than our initial expectations. Our rollout continues in 2023 and we will have this product on 84% of our international wide-body fleet by this summer. Our loyalty program continued to exceed our expectations with record SkyMiles acquisitions in 2022, 42% higher than 2019. As Ed noted, we are partnering with leading companies to expand our loyalty ecosystem, increasing the value of our program for customers and deepening customer engagement with Delta. With an expanding ecosystem and free, fast WiFi, we expect continued growth in our loyalty base. Our partnership with American Express delivered record results, with full year remuneration of $5.5 billion, ahead of our initial target and positioning us to deliver over $6.5 billion in 2023 and over $7 billion in 2024. Cargo revenue was a record in 2022 and we expect to grow cargo revenues in 2023, as increased capacity offsets the cargo yield environment. With strong execution across our business lines, a record 55% of revenue was generated by premium products and diverse revenue streams. We are confident in our path to exceed 60% by 2024. While not without challenges, 2022 was a strong year for Delta and we exited the year with momentum. During the December quarter, we generated revenue of $12.3 billion, 8% higher than 2019 on 9% less capacity. We saw revenue recapture at the end of December that offset the impact of weather disruptions in our system around Christmas. Fourth quarter unit revenues were 19% higher than 2019, with strength driven by consumer demand throughout the quarter. Corporate travel demand was steady through the quarter, with corporate domestic sales 80% recovered to 2019 levels. We expect March quarter revenue to be up 14% to 17% higher versus 2019. On capacity approaching full restoration, we expect March quarter unit revenues will be up 15% to 17% compared to 2019, including a 2-point impact from higher stage. Based on how we are deploying our network, our stage length is expected to be up 5 points compared to 2019, resulting in a higher restoration of ASMs and seats. This is a temporary dynamic that is unique to Delta among major carriers. Stage will begin to normalize relative to 2019 and relative to the industry as we rebuild our core hubs later this year. For 2023, we expect to grow revenue 15% to 20% year-over-year as we fully restore our network and further diversify our revenue streams. Consumer demand remains healthy, with advanced bookings significantly ahead on both yield and load factor for each month of the March quarter compared to 2019. And in our recent corporate survey, results were positive with 96% of respondents expecting to travel as much or more in 1Q than 4Q led by financial services. In the New Year, bookings reflect the survey optimism and are accelerating. International revenue continues to be led by the transatlantic. We are seeing robust demand across our expanded footprint in Europe and expect the spring and summer to set new record revenues. Latin America is performing very well, led by Mexico, the Caribbean and Central America, with a recovery in Deep South America now accelerating. And we are pleased with the early results from the launch of the LATAM JV and I am excited about the opportunities for us in 2023 and beyond. In the Pacific, we expected record first quarter profits in both Australia and Korea as our multiyear international transformation delivers on anticipated results. Japan is also building momentum and we expect a very strong summer there. In closing, we delivered on our key commercial priorities in 2022, supporting a significant improvement in our revenue, while strengthening our competitive advantages. We have started the New Year with great momentum and are well positioned to extend our leadership position in the years ahead. Great. Thank you, Glen. In 2022 we made significant progress restoring our financial foundation. We delivered earnings of $3.20 per share, with pre-tax income of $2.7 billion, ahead of our plan. Operating margins of 7.8% was driven by three quarters of double-digit margins. We improved profitability and the strong advanced bookings. We generated $6.2 billion of operating cash flow, enabling continued investment in our people, our fleet, our partners and technology. After gross CapEx of $6 billion, we generated $244 million of free cash flow. We ended the year with liquidity of $9.4 billion and adjusted net debt of $22.3 billion. Our adjusted net debt to EBITDAR was 5 times and our after-tax return on invested capital was 8.4%. We finished the year strong, reporting a $1.4 billion operating profit on a margin of 11.6% for the December quarter. Our non-fuel costs were 13.4% higher than 2019, in line with guidance, excluding a 1-point impact from the severe winter weather in late December. Now moving to guidance, as Ed mentioned, we are including all expected labor rate increases in our guidance metrics, including non-fuel CASM. As it relates to our pilots, if they vote to ratify the proposed agreement by March 1st, pay rates would be retroactive to January 1st. This results in a 3-point impact on our non-fuel unit costs for the year and in each of the quarters. Including this in the full year guidance we gave last month brings our 2023 non-fuel unit decline to 2% to 4% on a year-over-year basis. Delivering a competitive cost structure is a key financial priority. Delta has led the industry an investment in our people and our customers and this is embedded in our outlook, as is a full reset of regional costs and inflation. As we move through the year, scale and efficiency will drive a decline in 2023 non-fuel CASM versus 2022. While approaching 2019 capacity provides scale benefits, we are still bearing the cost to fully restore our network to the peak summer levels, with a continued emphasis on operational reliability during this ramp-up. We expect to complete our rebuild by the second half, with the majority of our flex fleet reactivated and training levels for our pilots reverting to historical levels. This will allow a significant shift of resources from training to production, giving us the confidence in our ability to deliver a fully restored network during the peak summer period, while enabling our operating teams to drive efficiency in the back half of the year. One unique item within the year is the pacing of our core maintenance, as we prepare to step up the network for summer flying with the first half year-over-year higher than the second -- and then lower in the second half of the year. While these dynamics impacting early part of the year, we expect 1Q non-fuel unit cost to increase 3% to 4% on a year-over-year basis. We expect the year-over-year unit cost to progressively improve through 2023 as we complete our rebuild and elevated maintenance activity, while driving efficiency across our operating groups. This cadence is consistent with our full year outlook for non-fuel unit cost to decline 2% to 4% year-over-year. With our outlook for revenue, we expect the March quarter operating margins to be 4% to 6% and earnings of $0.15 per share to $0.40 per share. For the full year, we are regulating our outlook for earnings of $5 per share to $6 per share and operating margins of 10% to 12%, delivering a 2-point to 4-point expansion of margins, including over 1-point impact from higher profit sharing. We expect the full year free cash flow to be more than $2 billion with gross CapEx of $5.5 billion. In 2023, non-operating expense is expected to be $470 million higher year-over-year. These results from non-cash pension expense increasing over $550 million year-over-year due to broad market declines, more than offsetting the reduction in interest expense from repaying debt. We plan to pay cash for our $2.4 billion in debt maturities, while opportunistically reducing debt with excess liquidity. This will bring our leverage to 3 to 3.5 target for 2023 and remaining on track for 2024 adjusted debt-to-EBITDAR to be 2 times to 3 times. Returning to investment grade metrics by 2024, while continuing to reinvest in the business remains our focus for capital allocation. In closing, I want to thank -- add my thanks to the Delta team and people for their hard work this year. We outperformed the first year of our three-year plan and we entered 2023 on track to generate a significant improvement in both earnings and cash flow. We remain confident in delivering on our 2024 target of $7 of earnings per share and generating over $4 billion of free cash flow. Good morning, everyone. So good to be back. So maybe I will start with a question on the capacity bottlenecks that you mentioned in your prepared remarks Ed. So I know Delta itself has made a lot of progress in hiring and getting through a large wave of training, but there are other constraints outside of the airline industry’s control with aircraft delivery slower than planned and aviation infrastructure still fairly strapped at airports, the FAA. Now I know the answer will be different for Delta than some of your peers who are further behind in their pilot hiring, but how do you think about the time line to remove some of these bottlenecks across the industry that aren’t directly in airlines control and I guess really what I am asking is, do you expect there to be continued tension between supply and demand over the medium-term, just how do you think about those rolling off? Thanks so much. Thanks, Catie, and welcome back. Yeah. I think you summed it up well and I mentioned at the Capital Markets Day last month that while we -- at Delta and I think the industry broadly provides you, our capacity expectations. I think expectations have quotation marks around them and they do feel still a little bit more aspirational than because there are a number of things that are outside of our control. We are doing our very best to get our people in place. The hiring is strong. We have the team assembled. We need to get them through, principally our pilots through the training -- the limited training devices and school house that we have available to us. We expect by the summer that we will be in position to have not just get through most of that bottleneck, but then the large resource drain that it takes with respect to all of the training that are existing team has to do to train our new employees, whether that’s pilots or flight attendants, mechanics, the airports, reservations. It doesn’t matter where in the system you sit. That’s hard to see. I can appreciate that if you are sitting in your chair, but it’s very meaningful here on the airline. And then by summer, we hope at Delta that we will be able to be back 100%. I also use the term fragile last month when speaking about the aviation system as we continue to return to the skies, and I think we have seen just in the last few weeks a couple of illustrations of that fragility. So we are going to continue to do our best to make sure we don’t fly in excess of our capabilities so that we can deliver a great product for our customers and provide all the tools and support for our employees. That’s great. Helpful, Ed. And if I could maybe just for my follow-up. Glen, I know 75% of this year’s growth by your core hubs. Can you help us think about RASM performance at your core hubs versus the rest of your network or even better since we know its lower cost capacity? Can you help us think about the margin differential of adding capacity in core hubs versus competitive coastal hubs? Thank you so much. Sure. I think we outlined that at the Investor Day and core hub is about 10 points higher than coastal hubs and 10 points in margin. And about 20 points in terms of RASM. I think as we continue to build our core hubs out we will see, that’s one of the things we are counting on is acceleration of profitability in those core hubs and driving efficiency so we are getting them back to scale. As we mentioned in our Investor Day, we are already at scale in our coastal cities. That was our priority, just because we thought it was a once in a lifetime opportunity during the pandemic and so that was our priority to ensure that we came out in a good position there. I think we are very happy with the positions we have established there and now it’s back to the core where we think it’s actually easier lifting. Thank you. Good morning, everyone. Ed, you said in your prepared remarks that you have never seen a more constructive industry backdrop. Black Swan event aside, what do you see are probably the biggest risks or things to watch out for the industry in 2023? Is it your previous response on kind of infrastructure and things that’s outside of your control or kind of what are you looking at? Well, thanks, Ravi. I -- that’s right. I think the most important thing that Delta we can do is to continue to restore confidence back to the traveling public. We know the traveling. The public wants to travel in outsized amounts that we see continuing and we have to do our very best not to disappoint them as they return to the skies, I think, 2022 was very difficult. In that regard, demand clearly exceeded our ability to supply it for lots of ways, including in the service levels with the exceptional degree of service that we want to provide our customers. And I think we all in the industry owe it to our customers to make sure we don’t fly in excess of our capabilities. So I think that’s the single biggest thing that we all need to pay attention to and so I wouldn’t call it a Black Swan risk other than just trying to stay within our capability. Understood. And maybe as a follow-up maybe for Glen. Can you just unpack your thoughts on corporate in the near term, a little bit more, I think, that’s, obviously, one of the big focus areas for investors right now. You said 96% of corporate in your survey say that they are going to be kind of flat to up in the near-term, but obviously, macro is really choppy. We saw some of the hotel data kind of coming into January take a bit of a step down. What are you seeing in terms of your booking curve kind of any signs at all on cracks and corporate demand given where macro is? We have had our highest post-pandemic days in terms of corporate booking over the last week or 10 days. So we see a very strong post-holiday demand set. We are in kind of a strange period right now because you over 2019. This is an MLK weekend and MLK weekend was next weekend. So I think once we get past MLK, we will give you a better view. But we are counting on it to stay in that roughly 80%. That’s not -- the survey would indicate that it’s better than that. So I think that’s -- if it does materialize is better than that, that’s upside for our forward looking forecasts. Hey. Thanks. Good morning. Glen, if I look at the RASM guide for Q1, down about 6% just in absolute terms from Q4, so that’s worse than normal Q4 to Q1 seasonality. Any color on that and then when do we really start to see this hub tailwinds show up in RASM? Right. Well, quarter-over-quarter, we had a 2-point increase in domestic stage. So, and that again is unique to Delta and we think that’s about 1 point of pressure from the 19 down to the 16. There’s another international mix, length of haul changing internationally as well. So that’s another point. And so then we are thinking about this as really being sequentially about 1 point difference to get from a 91% restoration all the way up to 99% restoration. So our core -- for core same-store sales, we are actually seeing first quarter being stronger than fourth quarter and with that sequential improvement from February being better than January and March being better than February. So I think we are sitting in a pretty exciting place right now as we look at how 2023 is starting. The rebuild of the core, we wish we could do it sooner. Again, I think, our priority has been to make sure that we can sustain industry leading operations and so that’s going to work throughout the year. I think when we talked about it at the Investor Day, we didn’t really give you color that this is not a first quarter event. While there’s some rebuild domestically in the core, the major rebuilds we expect, for example, Atlanta, which was about 85% last year in terms of seats to be close to 95% by summer and then 100% by fall with Minneapolis close to Atlanta and then Detroit a little bit behind. So we are working on that, that’s our priority and we will get there we believe by fall, but it really doesn’t impact significantly the first quarter’s core. Okay. And then just for Dan, just help bridge us from CASM up 3% to 4% in Q1 to down 2% to 4% for the year? You mentioned maintenance, how much does that hurt Q1, how much has that then helped the back half, any color here? Thank you. Yeah. Certainly. There’s two pieces in there. Maintenance being one, it’s about a 2-point headwind in the first quarter and first half and it’s driven by engine induction levels and scope of work related to that. As you get into the back half of the year, that’s a 2-point to 3-point benefit year-over-year, so a 5-point progression from beginning to end. And then the second piece of that is related to the completion of our rebuild and those rebuild costs stepping down. Most of our rebuild over 85% of that cost is in the first half of the year. You don’t have that in the back half of the year. And as Glen just talked about, one of the enablers that efficiency is, as we restore the core hubs, these low-cost subs, low CP most cost competitive as we put that capacity and that drives efficiency of our assets and our workforce. That is 5 points. So the 5 points related to that and the 5 points related to maintenance is 10-point progression as you go through the year from the beginning to the end and that drives that continuous cadence improvement as you go through the quarters. Thank you, and good morning, everyone. First, I wanted to maybe ask about just profitability levels. You finished the year with 8% margins and are guiding to Q1 with 4% to 6%, and given the full year guide, how do we think about margin progression throughout the year? It will -- part of it is tied to the cost progression and as you see that progression being up, and I said to you get about a 10-point improvement in cost from beginning to end, that will drive your expansion of margins throughout the year as you progress, along with what then Glen talked about, which was the commercial rebuild related to the core. So you will see this progression. Certainly, year-over-year, the improvement versus the comp that we are coming off drives some material improvement here in the first quarter over $1 billion pre-tax, a big part of the step-up in earnings year-over-year, but you will also see improvement as we go through the year. That’s helpful. And then just maybe one follow-up related to that, just margin progression. I think, Ed, you mentioned high margin Pacific routes opening up, I think, it was Australia and Korea, what are one time to two items we should watch for as we see that international recovery help margin momentum? Our international recovery is well underway, and if you think about Europe, it will actually be bigger in the transatlantic this year than we were in 2019 by about 8 points in terms of seats. Early advanced bookings for that are incredibly strong, so we are very pleased with how that’s developing. And so what’s really left to reopen is China and that’s -- we are not going to get ahead of ourselves in terms of capacity to China. We are going to be very mindful to see how demand warrants and how this opens up, but that’s the big question mark, I think, in terms of international demand for 2023 that we don’t know yet. I think the others we are very confident that we have a good path forward that will get us back to 2019 or bigger at better margins. And I think as we talked about at Investor Day, the multiyear progression on international, the structural elements here, right? The next-generation fleet that we are at, the reconfiguration of more premium seats with DPS, better cargo capability stronger partner network, all those are systematic drivers not only in this year but really on a multiyear basis. And if you go back in our history, not to go into too much detail, but we had a multiyear restructure of our Asia capacity and that has been a drag on earnings for many years leading up to the pandemic. And now as we come out of that, we feel like our restructuring is really done in earnest and so we should see really good improvements in specific profitability moving forward. Hey. Good morning, everybody. And Glen, it’s been a while since we visited the topic of domestic and international RASM premiums. We know what those metrics were pre-COVID, there’s obviously been quite a bit of international upheaval since then, a bit of domestic change, and of course, the premium market at least is stronger than what I was anticipating in 2019. How should we think about the magnitude of Delta’s RASM premiums going forward and any related timing? Yeah. I think right now we are sitting probably at a low point relative to the industry given our stage length and the way we rebuilt the airline and I would expect to gain a couple 2 points to 3 points domestically back as we get towards the back half of the year on how we rebuild the airline. So that’s how I view it. I am pleased with -- at a macro level or at an individual flight level, I am pleased with where we are. When you add it all up, sum total looks like we are taking a step backwards, but I think, it’s really the way we have done it rather than a structural look away from Delta or anything that we are losing customers. So I think we are in a good spot for that. Okay. Thank you. And second for Dan, as we think about the order book, particularly on the wide-body side, considering the OEM backlogs that -- Catie, welcome back by the way, I mentioned in her question. How should we be thinking about the cadence of CapEx in the coming years? We tend to model you on a normalized basis, but one of your competitors is on a CapEx holiday, another right now is on a CapEx vendor. I am just trying to assess whether 2024 represents a potential peak in cash flow in light of future aircraft needs? I think it’s steady as it goes. We have been very consistent, very deliberate, very disciplined related to CapEx. We certainly had this period where this past year in 2022, there was some catch-up in there. We are continuing to do that here in 2023 for what was deferred for a couple of years. But I think as you exit 2024, you are normalized. Now, at the same time, we are getting bigger as an airline and growing from that perspective, but I think with -- it’s a good foundation for us as it relates to where we are stepping off in 2024. Yeah. Jamie, this is Ed. I’d agree with Dan’s comments. Don’t forget we are exclusively taking Airbus equipment over the last couple of years, the next couple of years pretty much and we will be back with the MAX starting in 2025. So we did not have any supply interruption of any note over the last couple of years through the pandemic this year or the years going forward. So there’s a consistency and I am confident you are going to see a -- you are not going to see any jumps or any significant declines. We are ensuring that we are staying rated within our sweet spot here on the fleet. Hey. Thanks. Good morning and thanks for the time. Maybe just start with Glen on transatlantic. Typically, this is a pretty quiet time of the year, but it appears the industry is sort of doing less seasonal shaping or kind of deseasonalizing transatlantic, which probably makes sense in light of rebuild for the summer. Can you just talk about what you are seeing in transatlantic less about this summer and more about getting from here to there? Right. Well, there’s not a lot of room between here and there. We are seeing really robust bookings for March and beyond. So it’s really, if I look at how we view the transatlantic, there’s April through October peak spring, March is getting to be a peak month these days. So that leaves you really the non-holiday weeks in November and the non-holiday weeks in January and February as really your low periods and so how we have shaped it this year is we have had a bigger transatlantic in 2019. We had some operational issues in Amsterdam. Excluding those, we were very pleased with the results in the off-peak season and it’s setting up really well. Because I think one of the things that you forget about building up for the summer is the first few weeks for the high point of sale U.S. travel are always throwaway weeks, because you have got a significant amount of outbound traffic and very light inbound traffic. So getting those out of the way earlier in the season and really allowing the summer peak to be even more robust than it has been before is, I think, how we are shaping. So I don’t know if I answered your question, but I’d say we really like what we saw. There are things we are going to do differently next year. There are learnings from this year that we can improve on. So we are excited about those learnings and then really excited about the summer peak season to Europe. We think this is going to be a record breaker. Thank you, Glen. And then just on fuel, maybe this is Ed or Dan. You own a refinery. Can you talk a little bit about your outlook for jet fuel, and I am not asking for guidance, we can obviously see that. But just with respect to the unusually high crack spreads and refining margins, which week-to-week look like we are going to get relief and then that relief sort of goes away, obviously, you have a hedge in that regard, but I wondered if you could talk kind of intermediate term about when the -- when we see sort of refining margin relief? Yeah. No. You saw it constrained markets throughout 2022 state elevated certainly was disrupted significantly in the second quarter, particularly we don’t anticipate it being at those levels for the current year giving back. But I would say for the next 12 months to 18 months, I think, you are at least in a period where you are structurally constrained. The global flows for both oil and refined products have changed. Things that used to revert both gasoline diesel and jet coming out of Europe into the U.S. aren’t taking place. Utilization of refineries are high and you get disruptions, you have seen it as the winter storms came through in December and incredibly low temperatures. Refineries were impacted and you are seeing the rippling effect here in January and the unusual nature even in the last seven days to 10 days, where the physical market is short. Jet many times throughout 2022 it was diesel and you see a spike. And then the -- as the refineries get the utilization back up and optimize you get a balancing, but they are still tight and we expect them to stay elevated. Hey. Good morning. Glen, could you talk a little bit more about what you are seeing on the corporate demand side on the -- across the international entities and just as you get to the summer, I realized it’s early days, but where you expect kind of capacity be restored across these entities? Yeah. I think we talked a little bit about that in the previous question, we expect the transatlantic to be about 108% restored to 2019 levels, so it will be bigger than 2019. Most of that is engaged as we bring in the newer, more efficient fleets. So we have some exciting departures. We haven’t loaded our entire summer schedule yet. That will be announced over the next 8 days to 10 days. There are a few more things we need to put back in. And then in the Pacific, absent of China, we are more than rebuilt in Australia, we are more than rebuilt in Korea and we are about 75% rebuilt in Japan. We expect to be somewhere between 75% and 100% rebuilt in Japan. If we do or don’t receive slot waivers -- if we do receive slot waivers, we are probably sitting at 75%. If we don’t, we will go back to 100. And then China is the big question mark, as I mentioned earlier. We just don’t know what’s going to go on there with demand. So we are not going to get ahead of that and publish a China schedule for the summer that we don’t know if we can fly and we don’t know if the demand will be there. So we will let demand drive what we are going to fly in China. And then last but not least, in Latin, we are very close to fully restoring Latin right now with Deep South really starting to turn on with our partners at LATAM and getting some really, really positive early results on that. So I think other than China, we are fully restored internationally and we see international restoration where countries are open and that’s very similar to domestic at about 80%. I appreciate that. And just kind of a quick follow-up, just on the kind of change fees and the revenue that you are seeing here, the dropping of the change fees, what kind of an impact is that having as you kind of think about the network or the revenue and will it be different once things are fully restored versus where it is today? Yeah. Change fees accounted for almost $1 billion of revenue in the pre-pandemic world and we were on a path even absent the pandemic to change fees. They have become onerous, people didn’t like them and trying to give customers what they want, we were on a path to a different approach that got accelerated and I think we are very happy with where we are today, giving customers choice in how they want to fly. And I’d say we are counting on about half of that $1 billion to be replaced by people who want flexible, fully refundable at time of purchase, which is an option that they are choosing as opposed to being imposed on that. And the rest of that is then coming from a higher share of total customer base and upsells more than covering to produce the record revenues that we expect this year. Hi, everyone. Thank you for the time. Just on the question that Scott talked about the bridge on the cost side. I don’t think you mentioned gauge or asset utilization improving throughout there. Can you just provide some color around where you expect those two metrics to kind of be meaningful tailwinds as you move throughout the year? The reason why I asked is that, there’s a lot of changes on the regional side, I would think that, that would be a pretty big tailwind from you? Yeah. The mainline asset utilization increases about -- mid single-digit about 5% as we progress through the year. So we get the benefit associated with that and as we talked about at Investor Day, we continue to get the benefit associated with gauge. Related to regional flying, as you know, we have about a third of our regional flight that flying that has not been flown today and that’s also one of the disparities between seat restoration and capacity restoration. We are not expecting a significant increase of that until the end of 2023 and into 2024. So we are going to be carrying that… Okay. Okay. That makes sense. And then on the Amex targets, I am a little surprised that those aren’t being revised up from 6.5%, from 5.5%, I mean that’s basically mirroring the capacity growth year-over-year. I would just think that there would be some outperformance just given the fact that, that portfolio has grown a fair bit. Can you just talk about like what you need to see to push those targets up or did you just see a lot of pull forward in consumer spend that kind of inflated the 2022 number, just trying to unpack that a little bit? Thank you. Well, we are pretty excited about hitting a $6.5 billion number. Hopefully, there’s upside to that. I think its January. We don’t want to commit to that. But we are ahead of our long-term goals for that and we continue to find ways to accelerate our long-term goals. And I think next year or maybe even in June we are going to give you what’s beyond the $7 billion, because our first market was how do you get the $7 billion, and when we said that, I think, it was a daunting task for us, it was a daunting task for the team, we are there, right? And I think the question really for us and I was investors, okay, you are at the $7 billion, what’s next, and that’s what we have got to be working on showing you that we are not done here. Yeah. Yeah. And the other thing -- Conor, this is Ed. It’s not driven by capacity, as you can appreciate, it’s driven by the spend on the portfolio. So that’s a pretty sizable increase in portfolio spend as well. Thanks very much, Operator, and hi, team. Thank you. Sort of a question about TechOps, pre-pandemic, you guys were building that business out, it was going to be a more than $1 billion revenue business at some point. How are you thinking about that coming out of the pandemic and into sort of the middle part of this decade into the end or is that something that is another focus or is that being supplanted by the other revenues that you are talking about? … incredibly excited about your question and the MRO, and in fact, we made great progress during the pandemic to continue to accelerate that vision when we sign a deal to acquire the LEAP as part of the MAX deal. So we now have basically all the new engine technologies on our platform with exclusive arrangements and opportunities for third-party work that will extend over the next 20 years. Obviously, in the short-term, our focus is on -- to every extent we have labor and we have supply challenges focusing on the Delta metal and continuing to get the airline itself back up and running. So the MRO has taken a little bit of a backseat over the short-term. But we continue to make the investments where we have got the commitments from all of our partners on the engine side and this is something you are going to hear a fair bit about in June when we look at the strategic discussion that we are looking to create. Right. In June. Okay. That’s going to be really helpful. And then, Ed, can I please ask you in June, if you will also update us on your diversity and inclusion targets. We talked a lot about that pre-pandemic and then during the pandemic, you have obviously hired 25,000 new people. You mentioned that in your prepared remarks. Can you also at some point update us on how that’s going and whether you are meeting your own internal goals? You don’t have to share those with us, but if you can share with us how it’s coming along? That might be helpful. We will certainly do that, and that was already in the plan, Helane, to go through that in June. The good news is that we are making great progress and we will share our targets, because we share them publicly. Hi. Good morning, everyone. First question for Glen, I guess, based on my math, it seems like you are assuming PRASM could start to decline sort of in the high-single digits year-over-year as you move through 2023 to kind of get to your 15% to 20% revenue outlook. What drives that assumption particularly given kind of the RASM benefit you should have from your mid-continent growth strategy? I think when we look at the progression through the quarter we had some very extenuating circumstances last second quarter and early third quarter with fuel running up over $120 a barrel. And as we think about how we do fuel recapture on the way up, we also as inflation cools down and as fuel comes down, we are not going to keep all of that. We are going to keep as much of it as we can and we are not anticipating that big mobile and fuel, which is driving the sequential decrease. So we will see how it actually rolls out and hopefully it’s better than that, but that’s how we are thinking about how the year progresses in terms of absolute unit revenues. Yeah. That makes sense. And then I just ask you kind of strategically here, Glen. As you see -- as you have seen the revenue environment continue to show this strength pretty much since kind of almost a year ago, are you seeing any changes in behavior from any of your competitors that may show that they are acting differently today than they would have pre-pandemic? Thank you. Yeah. We don’t really talk about how our competitors behave. I think what we have seen is we have seen a very big shift in how and why people travel and trying to stay ahead of that in our own planning and make sure that we are capturing where people want to go and what products they want to buy and that’s really our continued focus and it’s been a very interesting journey. And as you look at individual market levels, we are very different sizes than we were pre-pandemic based on where our customers want us to take in these days. Oh! Hey. Good morning, everyone. Hey, Glen, just a quick question sort of following up on Conor’s on loyalty. It feels like with the free WiFi, this is going to be a banner year for SkyMiles, I think, last year $8.5 million. How do we think about the conversion of number of SkyMiles to ultimately those who take -- uptake on the credit card, I think this last year, it was like an 8:1 ratio. Is that kind of what it’s been historically? Yeah. I think that’s about right. That’s one of the -- we see the more engaged the customers with Delta, the higher their satisfaction is and so that’s really part of that ecosystem that we are really trying to grow is, SkyMiles is an entry point, of course, as everybody knows it’s free and now they have an incentive to do that, because there’s an immediate benefit to join because you get the free WiFi and so how do we translate that ultimately into more loyal customers who eventually will wind up getting some of our other products and that’s really what our flywheel is right now and how we are going to continue to press forward in terms of loyalty. Great. Very good. And then just second question on Dan, you talked about non-ops, the $470 million headwind, obviously, non-cash pension expense maybe there’s some other items. How do we think about through the year, is that ratably, is it lumpy and what tax rate should we be using on March quarter full year? Thank you. Yes. 1.3 for the year. The first quarter think of it being closer to -- if it was ratable, it would be about 3.30 a quarter. First quarter will be a little bit higher. We think about it as 3.60 to 3.65 associated with it. And tax rate continues to be consistent, right, in that 24% to 24.5%. Keep it to one as well. Dan, can you talk about your normal amortization this year, which I think is about $2.5 billion relative to the $2 billion of free cash flow that you guys are anticipating? And what are your options here, especially in a higher interest rate environment, how does that change your capital priorities in any way? Normal -- yes. We have normal maturities at 2.4. We had 1.8 this past year and we ended up retiring $4.5 billion of debt. Ken and the team were opportunistic in regards to debt that we can take out that we think is higher cost and has good economic payback associated with it. And given our liquidity position, as we progress through this year, we will continue to look at those options. There are certainly a number out there that are targets for us, but we will either do it through how we have done it with through tenders, but also just as you go open market repurchases and being smart and going after the higher cost debt, that’s a priority. We want to drive down that non-op interest line over time and the team is good at it. They have done it. Did it for a decade. They will continue to do it. About changing it, I think, it does -- when it may change in regards to how you look at some of your debt, some of them that are off of LIBOR and floating have become more attractive to retire in certain situations. So, but we are continuing to be focused on, as you know, it’s reinvesting back in the business, but also this path to deleveraging. So continuing to strengthen the balance sheet, reduce debt and drive down those leverage ratios. That will wrap up the analyst portion of the call. I will now turn it over to Tim Mapes, our Chief Marketing and Communications Officer to start the media questions. Thank you, Julie. Matt, if you don’t mind, could we reiterate for the members of the media, the practice for getting in the call queue and in addition to thanking each of them for their time this morning, just to remind everyone around one question and one follow-up so we can get through as many of these as we could please. Thank you. Hi. I was wondering, what needs in your opinion to happen at the FAA so that what happened on Wednesday doesn’t happen again? Hi, Claire. It’s Ed. I missed the first part of your question. Your question is what does the FAA need to do in order to ensure… Well, if you saw my comments this morning on CNBC. I think it’s very clear that there has to be a call to action amongst our political leaders, the Congress and the White House to fund and properly provide the FAA the resources they need to do the job. We have long talked about the need for modernization of our air traffic control systems. I think this is a crystal clear example of the challenge the FAA has faced when you have aging systems that aren’t as resilient as they need to be. You have tools and technologies that are somewhat outdated and staffing levels, not where they need to be. So FAA I know is doing the very best they can with what they have, but we need to stand behind the FAA and we need to take them off the kind of year-by-year funding that seems like they go through that’s caught up in political negotiations and realize the importance of having a strong aviation infrastructure and the importance of that to our economy, as well as our public. Hey. Thanks so much. I guess sort of a related question, but I guess curious, how much do you think that the infrastructure and aerospace issues are likely to be a constraint on growth for the industry overall, whether it vulnerability of technical systems and lack of redundancy or just controller staffing or what have you, how impactable do you expect that to be going forward? Well, it’s according constraint on our ability to grow as an industry. You see the length of flight times they are taking to complete missions. You see the some of the challenges the air traffic control -- controllers have when you get into congested space in the Northeast or down in Florida. There’s been a lot -- it’s just even during the pandemic itself some real challenges that we have experienced. So there’s no question that the investment in a modernized air traffic control system will drive a tremendous amount of efficiencies, as well as growth, which will mean better service for the American public. Thanks. And I guess can you talk a little bit about sort of what sort of systems or backup or its own redundancy Delta has, like if there was another outage of the NOTAM system like we saw earlier this week? Is that something that Delta can kind of deal with or work around or is that something you need to have or, yeah, there’s anything you can share on that? Yeah. The NOTAM system that went down is an essential system and no airline would fly without having that capability. Interestingly, at Delta, we had and have a long -- a fairly old backup technology that does see that and we were able to keep some of the NOTAM information flowing to Delta. So we probably had a little better opportunity to fly during this stoppage as compared to anyone else, but out of deference to the FAA and making certain that we gave them the ability to make the decisions we didn’t utilize that backup system. But it’s an important part of our resiliency and redundancy. Thank you. Your next question is coming from Kelly Yamanouchi from the Atlanta Journal Constitution. Your line is live. Kelly Yamanouchi, your line is live. Your next question is coming from Mary Schlangenstein from Bloomberg News. Your line is live. Hi. Thank you. I just wanted to see if I could get you to talk a little bit more about your comments about business bookings remaining steady. It seems like the 80% recovered level in the December quarter is what you had been saying previous to that and I wanted to see if you have got any sort of an outlook beyond the March quarter that gives you confidence that, that corporate recovery is not going to stall at some level? We do those corporate surveys, and that’s why we do them to see what our corporate partners are thinking about in terms of future travel and it was actually the last one we did, which is for future travel, was the best survey we have had since pre-pandemic in terms of their enthusiasm that more people would be flying in future months than we are flying in current or past months. As I said in the call, we are not counting on that in our current revenue forecast, because sometimes that doesn’t come to fruition, but there’s a sense of optimism from this pent-up demand for business travel that we see could potentially offset any weakness in the general economy. And we are taking a very cautious look, but -- and we are counting on it being stable and not growing dramatically, but it looks like people think it will grow. I -- you see in the -- in our country a lot of businesses struggling to get their employees back into the office and I think this is tied to that. As companies return and employees return to office, you are going to see another step up in my opinion of return to more normal trends, including improved business travel. You think of a lot of the big accounts we serve are consultancies legal firms, accounting firms, it’s tough for them to get out on the road if they don’t have the offices open of their clients and their customers. So I think that’s the -- a little bit of the choppiness that Glen was referring to, because that companies are intending to open and have had some -- there’s been some stalls going on there, but I do think as we progress over the course of the year, you are going to see more and more of business being done like it used to be done than ever before. Okay. And if I can just follow up, I understand about your survey, but are there bookings that you can see at this point beyond the March quarter that gives you any idea of whether that weakness will continue? And then when you said you are counting on that corporate demand being stable, but not growing dramatically, that’s a change though from what you had been seeing. Is that correct, you had been seeing growth, but now you are seeing it more stable? Clearly, in the early parts of the pandemic recovery, we saw some accelerated growth. I think we have been pretty consistent at the past couple of quarters and we see some stability in the booking curve at about 80% of revenue. So as you know, business travel usually has the shortest advanced purchase windows and is mostly close in. So we would not have any further visibility beyond the next 60 days to 90 days that would be of any significant help in charting that water. Hi. Thanks for taking my question. I wonder if you could comment on if Delta saw any benefit from Southwest Airlines operational issues in December, was there an uptick in bookings people buying less ticket sent out, any color would be great? Sure. As you know, we had our own weather operations during the peak Christmas holiday travel period, and we saw after that, when we were fully recovered and Southwest was still not back in full swing that we had an uptick in our bookings. That’s trended in highly competitive with Southwest markets a little bit into January, but we think that will resolve itself over the next six months to 12 months. Yeah. Hi. When you talk about getting back to full pre-pandemic capacity in your major hubs, are you talking about seats or flight numbers? And then what percent of your gauge up, let’s say, in Atlanta, what will it be up this summer and how do you think about managing crowds as you increase gauge and bring your flight numbers back up to where they were or beyond? Right. We will probably not, for the next couple of years see the flight numbers we did in 2019. We will get seat capacity restoration to 100%, which means that gauge will go up significantly. When you look at our fleet evolution that was always our plan was to continue to grow not by additional departures but by larger airplanes, more efficiency, less fuel burn, better products and services and so that’s really what we are intending on doing. The pandemic accelerated that and so you have got our average gauge up by double digits right now. That’s partly because we keep taking larger airplanes partly because the regional fleets are less restored. And we think that will normalize out over the next 18 months, but we will probably not for the foreseeable future get back to the flight levels, although we will match or exceed by the end of the year at the historic levels in terms of seat capacity. Is there any with the higher gauge, do you end up with more crowded banks in terms of number of passengers or is that a swag by having less flights… …that’s why we have done these generational builds across our network is that, we knew that bigger gauge was coming, we needed to accommodate it and even for example, here in Atlanta, we have worked closely with the city to reconfigure the deconcourse to be wider than any of the other concourses to accommodate that increased gauge. So we have got short-, medium- and long-term plans to accommodate those gauges. But a lot of that was in our generational builds across the network and we don’t think that it’s going to be more crowded than it was in 2019 or feel more crowded.
EarningCall_1452
Good afternoon, and welcome to Numinus Wellness, Inc’s. Fiscal First Quarter 2023 Results Conference Call. A question-and-answer session for analysts and institutional investors will follow the formal remarks. As a reminder, this call is being recorded. I would now like to turn the conference call over to your host, Jamie Kokoska, Vice President, Investor Relations. Please proceed. Thank you, Emma. Good afternoon, everyone, and thank you for joining us for our fiscal first quarter 2023 results conference call. Discussing Numinus’ performance today are Payton Nyquvest, Founder and CEO; and John Fong, Chief Financial Officer. Joining them for analyst questions at the end of our formal remarks are Reid Robison, Chief Clinical Officer; and Paul Thielking, Chief Science Officer. The following discussion may include forward-looking statements that are based on current expectations and are subject to a number of risks and uncertainties. The risks and uncertainties that could cause our actual financial and operating results to differ significantly from our forward-looking statements are detailed in our MD&A for the quarter year ended November 30, 2022, and in our other Canadian securities filings available on SEDAR. Numinus does not undertake to update or revise any forward-looking statements to reflect new events or circumstances, except as required by law. Our first quarter results were made available earlier this afternoon. We encourage you to review our earnings release, MD&A and financial statements, which are available on our website, as well as on SEDAR. As a reminder, all figures discussed on today's call are in Canadian dollars. Thanks, Jamie, and good afternoon, everyone. I'd like to start by extending the utmost gratitude that our work is conducted on the unseated homelands of the Musqueam, Squamish and Tsleil-Waututh people and on sovereign indigenous lands and territories across Turtle Islands. At Numinus, we are committed to a path towards reconciliation through continuous learning, reciprocity and humility. Our strong fiscal first quarter performance demonstrates the success we're seeing from our efforts to drive revenue and margin growth throughout our larger cross-border platform. We're very pleased with the momentum that is building across all aspects of our business and the trajectory we're on. To make Numinus the first publicly traded psychedelics focused company to achieve profitability, which we believe is likely to occur in the next 18 months to 24 months. Overall, revenue for the quarter grew 35.7%, compared to prior quarter gross margin grew 41.9%, compared to 31.5% last quarter and gross profit grew 80% to $2.4 million during the first quarter. Much of this was achieved as a result of the strong highest appointment growth we saw during the last several months. In fact, nearly 19,800 appointments were completed during the quarter, a 13.7% increase compared to our prior quarter, with nearly 10% of all appointments being made by new clients, something that underscores the strong demand that exists for our services and the success we're having building our brand awareness. In our most recent quarter, our wellness clinic network generated 88% of our total revenue and generated an average gross margin of 37.9%. The mix of our client appointments during the quarter continues to demonstrate the effectiveness of offering an assortment of mental health services rather than just focusing on one type of treatment. By offering a wide range of mental health and wellness services, we're able to provide our clients with the best possible outcomes based on their unique situations and treatment needs. Approximately 24% of all appointments during the first quarter were Ketamine-assisted therapy=-related, just over 9% of the appointments were for Transcranial Magnetic Stimulation and the majority of all other appointments continues to be for talk therapy and wellness services delivered in-person and virtually, which are often a gateway for clients to explore other mental wellness treatments. We also understand that key to meeting the incredible demand for mental health services is finding enough qualified and dedicated petitioners to conduct this important work. As a result, recruiting therapists and medical professionals has been a key focus of ours over the last several months. And I'm pleased to say that, that as of the end of November, Numinus had 138 practitioners across our 12 wellness clinics, a 13% increase compared to the end of last quarter. Even more, the first several weeks of Q2, we have welcomed 17 additional practitioners, bringing our total practitioner account to [155] (ph) [Technical Difficulty]. [5:34] We firmly believe that recruiting and training practitioners is one of the most important factors in achieving our growth. As having a full roster of practitioners is directly linked to the number of appointments we can offer even more so than the number of clinics we operate. In fact, we're confident that we can reach profitability through our existing network of clinics once we're able to operate these locations at full capacity with full scheduled practitioners to reach clients. Operating as efficiently as possible remains a core component of our strategy to reach profitability as quickly as possible. We're continuing to identify and act on opportunities that consolidate supplier and agency contracts due to leasehold expenses and decreased cash outflows, while we're still retaining our client focus and growth ambitions. During the first quarter, we successfully reduced G&A expenses 8.5% from the prior quarter mostly through supplier negotiations and rationalization, reduced office expenses, renegotiated insurance contracts and other operational efficiencies in all areas of our business. We're also continuing to look at how we allocate -- how we are allocating our clinic space and infrastructure to ensure we're best utilizing our clinic capacity as we grow our client base. This may include expanding our clinical trial management services into additional existing facilities where unused clinical infrastructure exists until wellness clinic demand requires full use of the clinical space. In fact, Cedar Clinical Site Research or CCR, our CRO service division continues to perform remarkably well. CCR manages clinical trial sites for a variety of third-party life science companies, including many well-known psychedelic and traditional drug development organizations. CCR uniquely positions Numinus well for a variety of regulatory and drug approval tracks, as our clinical teams are trained and experienced in the specific protocols used during the clinical trial process of many third-party psychedelic drugs currently being researched. Should any of these drugs reach FDA approval, these companies are likely to need clinical infrastructure to provide those -- their protocols through, which Numinus may be exceptionally well-positioned to provide. In total, the CCR team managed clinical trial sites for 14 clinical trials during the first quarter, with a total of 191 clinical trial participants. These services generated $680,000 of revenue during the quarter and an impressive 70.9% gross margin, firmly establishing CCR's clinical trial management as our highest margin activity. To further establish Numinus as a key provider of psychedelic-assisted therapy training, during this quarter, we are pleased to submit a clinical trial application to Health Canada to conduct experiential psilocybin-assisted therapy training research. This new experiential training study will enable practitioners training to provide psilocybin-assisted therapy, the ability to experience and observe psilocybin session and further their understanding of the treatment. This is one of the first training programs with experiential option and something that further differentiates our broader practitioner training program from others offered. We are initially launching this program at our clinic in Vancouver, but we expect to expand it to other locations across Canada in the future. Just as important, the dosing used for this experiential training clinical trial will use our new EnfiniTea psilocybin tea product. This means that the trial will also measure the safety of using whole psilocybin mushrooms as therapeutic appropriate doses, something that has surprisingly not yet been conducted in a clinical trial setting to-date. We believe this data should facilitate further access to psilocybin-assisted therapy by Health Canada, and we're pleased to assist in driving that forward. During the first quarter, we also completed all treatments of Canadian participants in the mass USX study known as a multi site open label crossover study of the Phase III MDMA assisted-psychotherapy for post-traumatic stress disorder clinical trial at our study sites in [indiscernible] in Vancouver and Quebec. The study sponsored by MAPS and the MAPS Public Benefit Corp, but managed by Numinus treated clients with MD&A for treatment resistant PTSD. The study has been a focus of our Canadian research team this last year and we're very proud to have successfully treated all participants and seen this collaboration with MAPS through the completion. We continue to explore ways to collaborate with sector participants including MAPS to grow access to these important therapies. With that update, on our strategy and operations, I'll turn the call over to John to review our fiscal first quarter financial results in more detail. John? Thanks, Payton, and good afternoon, everybody. Our first quarter -- our fiscal first quarter highlighted our ability to drive margin improvement as our clinical activity grows within our existing infrastructure. Total revenues for the quarter were CAD5.7 million, a 618% increase from revenue generated in the same quarter last year and a 37.5% increase from the prior quarter. Revenues from our Wellness Clinic network comprised 88% of total revenue during the first quarter, in line with last quarter, indicating all revenue generating division of our businesses are growing. U.S. Operations comprised 86% of total revenue for the quarter, highlighting the important contribution from the acquisition of Novamind, which we completed in 2022. Overall, Wellness Clinic revenues for the quarter were approximately CAD5 million, a 35.3% increase, compared to just last quarter, eue entirely to the 14% growth in clinic -- in client appointments. Our U.S.-based CRO business, CCR generated 682,000 of revenue, up 38.8% from last quarter and continues to show great opportunities for growth. Our gross margins continue to benefit from economies of scale and our ongoing efforts to enhance the operating efficiency of our business. Fourth quarter gross margins were 41.9%, a vast improvement from 31.5% just last quarter and a significant increase, compared to 24.4% in the quarter before acquisition of Novamind. Gross profit grew to CAD2.4 million, an 80% increase, compared to CAD1.3 million in the prior quarter. Gross margin improved partially, due to our ongoing costs and payment and operational improvement initiatives. As Payton discussed earlier, much of this is reflected in the 8.5% reduction in G&A expenses brought to the last quarter. More specifically, we've captured significant cost savings through lower office expenses and insurance costs and reduced various other costs containing to non-revenue producing departments. Total net cash outflow during the quarter was CAD6.6 million. Comprehensive loss for the first quarter was CAD6.1 million or CAD0.02 per share. In terms of liquidity, we ended the quarter with CAD26.4 million of cash on hand. With growing revenue streams and margins offsetting some of our expenses, we continue to believe we are well positioned financially to sustain our business model, pursue our long-term strategy and achieve operating profitability. And with that overview of our financial results, I'll turn the call back over to Payton for some closing remarks. Payton? Thanks, John. We are continuing to see regulatory reform take shape across many parts of North America, setting new benchmarks for the future of psychedelic-assisted therapies. In the last several weeks, both Oregon and Alberta outline their final regulatory frameworks, which we're sure will provide great examples and lessons for other states and provinces as legislation continues to evolve. And we're seeing great progress across several psychedelic drug and therapy clinical trials. As many of you may have read MAPS recently completed their Phase III trial with very positive results, and anticipates publishing their final study data and making their new drug application to the FDA later this year. We expect MDMA assisted therapy will be the first to get approval at a federal level in the United States. Thanks to the important work MAPS has done. Estimates of these treatments will be available in the beginning in early 2024. Importantly, with federal FDA approval, we expect MDMA assisted therapy will be covered by many if not all U.S. Insurance providers for approved cases. Numinus has steadfastly focused on acquiring and building clinics that can meet the needs of psychedelic-assisted therapy protocols we expect to be approved in the future. This includes ensuring our clinics have therapy rooms large enough to comfortably hold a patient and two therapists, appropriate soundproofing and patient access to private bathrooms. Not all wellness clinic companies currently offering ketamine-assisted therapy have taken the same strategy and we're confident that Numinus is the best positioned clinic network to offer MDMA or psilocybin-assisted therapies as soon as they're approved. Our unique clinical infrastructure, market leading practitioner training programs and familiarity with many psychedelic therapy protocols currently being studied at CCR clinical trial sites have positioned us exceptionally well to launch psychedelic-assisted therapy services as soon as the regulatory landscape allows. Our strategy and focus remains on achieving profitability as quickly as we can. Doing so ensures our work will reach as many people in need as possible with a sustainable model, while rewarding our shareholders for their trust and commitment. We are reallocating capital towards only projects that grow our client base and revenue continuing to evaluate wave to reduce costs wherever possible and executing a strategy that is both fiscally responsible and aligned with where the industry is going, not just where it stands today. In recent investor conversations, I'm pleased to say our unique sector positioning is already being recognized and I hope to continue growing that understanding. We have a well recognized internal practitioner training program, which drives practitioner interest and helps develop a pipeline we can recruit therapists and medical professionals from. Our clinics have the infrastructure needed to provide MDMA and psilocybin-assisted therapy protocols most likely to get approval in the future. We have long established relationships with Max and psychedelic drug development companies through our clinical research site management business, and our fiscally responsible approach to growth and directing growth through existing clinical capacity is driving sector leading gross margins. In fact, we expect Numinus will be the first publicly traded psychedelic focused company to reach profitability. With a defined pathway to get there most likely in 2024, this is something I think we ought to be very proud of. Thank you. [Operator Instructions] Your first question today comes from the line of Michael Okunewitch with Maxim. Your line is now open. Hey there. Thank you for taking my questions and congratulations on the fantastic quarter. So I guess to kick off, I'd like to see if you could help quantify where that revenue growth came from, because it was pretty strong growth over the quarter. Was this mostly coming from the more mature clinics based in the U.S.? Are we seeing growth across some of the clinics that are earlier in their trajectory? Yes, the growth was really across, kind of, across the board. Compared to last quarter, Canada appointments grew about 26%, but off of a lower base. U.S. Appointments grew by 11%, but off a much larger number. So continue to see growth across the platform. All right. Thank you for that. And then as a follow-up, I'd like to just given the MAPS update that you mentioned earlier in the call, could you help understand how an approval in PTSD or MDMA could potentially impact the landscape for the delivery clinic model? Would you expect this going to increase volume and you expect pent-up demand? Would there be an impact to margins and top line given the massive economic benefit we've seen from the initial analyses? Could you just provide a bit more color on that? Yes. Obviously, I think all of the above from a demand standpoint, in particular, with PTSD, I think the demand is extremely significant and continuing to grow. MAPS has done an exceptional job of really being the steward and leader of this resurgence in psychedelic research. And obviously, the results that they've had from their clinical trials continue to be extremely impressive. I think with that and because this will be going to the FDA clinical trial process, the opportunity for insurance reimbursement only drives to more and more interest and accessibility. And I think with that also, with the clinical infrastructure that we built and really continuing to stay extremely focused on where we think the psychedelic therapy market is going. We've always really ensure that our clinical infrastructure is set up to be able to hold MDMA-assisted psychotherapy, which as I mentioned on the call, is quite a bit more rigorous and requires a particular, kind of, infrastructure that you don't see more broadly within the mental health space. So we think this is a huge opportunity for us to greatly impact the lives in a positive way of our client. And I think we'll see that in regards to revenue and higher margin as well. All right. Thank you for that. And then just one more for me and I'll hop back in the queue. So you identified a target for profitability of around 18 months to 24 months. So could you provide us a bit more color on what steps you're taking and what you would need to achieve in order to reach that milestone? Yes, over the last couple of quarters, burn rate has been a little bit higher as we've been integrating the Novamind transaction since closing that transaction and I think really highlighted by these financials. There's a lot of room to grow within the existing clinical infrastructure that we've got. And now that integration is going well and we're continuing to see growth. It's really just driving inefficiencies. And we believe that with the full roster of practitioners, we'll see profitability. And so the main focus is now around practitioner recruitment and just filling the capacity that we've got and as we get prepared for some of these other psychedelic products that we anticipate coming online early next year. And also with that, just continuing to look at ways obviously leveraging the CCR business as well, which continues to go exceptionally well, not only from a margin standpoint, but preparing us for when those other psychedelic drugs are approved as well. So we're really -- the service provider of choice for a number of those companies, which also helps our practitioner recruitment strategy as well. Okay. Thank you. Thank you for taking my questions. First question, how did your Canadian wellness, I think, network platform actually do on a same-store basis in terms of growth? Yes. So from – as I just mentioned before, from a growth standpoint, Canadian clinics performed well overall on a same-store basis revenue grew about 21% on the Canadian side. So very pleased to see the Canadian clinics growing, as well as the United States on. Okay, thank you. Any plans on the clinical research side, any plans to grow Cedar Clinical research into other regions or location? Yes, absolutely. Within the existing sites that we've, but also we see capacity within our clinical infrastructure to leverage more of the space that we've got into other locations as well, so definitely a focus of ours over the next little bit and especially again with more and more psychedelic companies moving into later-stage clinical trials gives us an opportunity to also engage with those companies, who ultimately will have products that will need to flow through a clinical infrastructure and continue to position ourselves as that service provider of choice for those different drug development companies. All right. And one more question for me. In terms of the cash burn, it seems like the cash burn in the first quarter was similar to that in the previous quarter. What is the profile going to be looking like in the coming few quarters now? Is that still going to remain stable? Or is it going to stop trending down? Yes, we definitely anticipate that number to continue to trend down. This quarter, in particular, was really about learning -- doing more learning and growing the revenue and profitability side and margin side of the business. But with that, we definitely have identified places where we can continue to reduce the burn rate and while also being able to grow the business at the same time. Thanks, operator, and thank you everybody for joining us for our conference call today. I look forward to speaking with you in April when we'll report our fiscal second quarter 2023 results.
EarningCall_1453
Good day, and welcome to the Hope Bancorp 2022 Fourth Quarter Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Angie Yang, Director of Investor Relations and Corporate Communications. Please go ahead. Thank you, Andrew. Good morning, everyone, and thank you for joining us for the Hope Bancorp 2022 fourth quarter investor conference call. As usual, we will be using a slide presentation to accompany our discussion this morning. If you have not done so, please visit the Presentations page of our Investor Relations website to download a copy of the presentation or if you are listening in through the webcast, you should be able to view the slides from your computer screen as we progress through the presentation. Beginning on slide 2, let me begin with a brief statement regarding forward-looking remarks. The call today may contain forward-looking projections regarding the future financial performance of the company and future events. These statements are based on current expectations, estimates, forecasts, projections and management assumptions about the future of Hope Bancorp otherwise referred to as the company as well as the businesses and markets in which the company does and is expected to operate. These statements constitute forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future performance. Actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. We refer you to the documents the company files periodically with the SEC as well as the Safe Harbor statements in our press release issued yesterday. Hope Bancorp assumes no obligation to revise any forward-looking projections that maybe made on today’s call. The company cautions that the complete financial results to be included in the quarterly report on Form 10-K for the year ended December 31, 2022 could differ materially from the financial results being reported today. In addition some of the information referenced on this call today are non-GAAP financial measures. Please refer to our 2022 fourth quarter earnings release for management's reasons and purposes for using non-GAAP figures and the reconciliation of GAAP to non-GAAP financial measures. Now, we have allotted one hour for this call. Presenting from the management side today will be Kevin Kim, Hope Bancorp’s Chairman, President and CEO; and Dave Malone, Interim Chief Financial Officer. Peter Koh, Senior Executive Vice President and Chief Operating Officer, is here with us as usual and will be available for the Q&A session. Let's begin on Slide 3 with a brief overview of our financial results. Despite the operating environment becoming more challenging during the fourth quarter, we delivered solid financial results, which reflect the benefits of the lower risk, more diversified loan portfolio that we have built and continued improvement in asset quality. Given the market's expectations for the economic conditions to weaken further in 2023, we became even more selective in terms of new loan production favoring businesses that are less impacted by consumer spending trends and are more recessionary resistant. Importantly, the lower risk, more diversified loan portfolio we have built continues to improve with our criticized and classified loans consistently decreasing over the course of the year. In the fourth quarter, we reported net income of $51.7 million, or $0.43 per share, while our pre-provision net revenue or PPNR was $78.1 million, both net income and PPNR were slightly lower than the preceding quarter, primarily associated with an increase in deposit costs attributed to the highly competitive market for deposits. However, with our solid financial performance as well as a positive shift in AOCI, we generated a 2.2% increase in book value per share and a 2.9% increase in tangible book value per share, while also increasing our risk-based regulatory capital ratios. Moving onto Slide 4. In the fourth quarter, we funded $793 million in new loans, which is lower than the preceding quarter, as it reflects a more selective approach to new loan production and our overall goal to target higher yielding floating loan assets, as well as a lower level loan demand resulting from higher interest rates, particularly for commercial real estate loans. The fourth quarter also tends to be a seasonally slower period for C&I loan production, which has become a major driver of our overall loan production volumes. As a result of the lower level loan fundings, we had a slight decline in total loans from the end of the prior quarter, although for the full year total loans increased in excess of 10% or 12.2%, excluding PPP loans, which is in the top range of our estimated target. Consistent with the trend that we have seen over the past several quarters as a result of the investments we have made to build our C&I lending capabilities, C&I loans continue to account for the majority of our new loan production. In the fourth quarter, C&I loans represented 54% of our total loan fundings, and the average rate of new C&I loans increased 162 basis points over the preceding quarter, largely reflecting increase in SOFR rates. In line with our focus on developing relationships with larger, stronger commercial enterprises, our corporate banking group accounted for 79% of our C&I loan fundings in the fourth quarter. We experienced the strongest contributions this quarter from our healthcare and telecom teams. And from a geographic perspective, we are starting to see growing contributions from the new additions we have made to expand our middle market lending in the Southeast and upper Midwest areas of the United States. In terms of commercial real estate loans, we have $324 million of fundings, which reflects a decrease from the preceding quarter due to lower loan demand. We attribute this decrease to industry-wide trends as a result of the higher interest rates. In addition, we are targeting lower risk property types and focusing on obtaining wider spreads as part of our cautious approach to risk management, while at the same time improving our profitability. With the targeted segments and increased loan pricing, the average rate of our new CRE loans increased 100 basis points compared with the preceding quarter. Overall, we saw increasing trends in loan pricing in all asset classes during the fourth quarter. Combined with the higher mix of C&I loan production, this resulted in our average rate on total new loan production increasing by 134 basis points over the preceding third quarter to 6.71%. Moving onto Slide 5. Demonstrating our ongoing transformation to a lower risk loan portfolio, C&I loans increased by 21.4% over the course of 2022. At the same time, commercial real estate loans grew by just 3.4% during the year, all-in-all resulting in loan growth of 10.4% for the full year. As a result, C&I loans as of December 31 of 2022, accounted for 33% of total loans, an increase from 30% a year earlier, and commercial real estate loans decreased to 61% of total loans down from 65% at year-end 2021. We have also had success in improving the diversification within each of the buckets of our loan portfolio. In particular, our hotel/motel portfolio represented just 10% of our CRE loan portfolio compared with 14% a year earlier. At the same time, our multi-family portfolio increased to 14% of our total loan portfolio at year-end of 2022 from 8% as of year-end 2021. These results are due to two primary factors. The first being the success we are having with our efforts to target more lower risk CRE property types, and the second being the growing benefits of the investments that we have made over the years to enhance our C&I lending capabilities. Thank you, Kevin, and good morning, everyone. Beginning with Slide 6, I will start with our net interest income, which totaled $150.5 million for the fourth quarter of 2022, representing a decrease of 1.7% from the proceeding third quarter. While we had recognized a 2.1% increase in our average earning assets in the fourth quarter, this increase in interest income from higher earning assets was offset by an increase in deposit cost. Our net interest margin decreased 13 basis points quarter-over-quarter to 3.36%. The average yield on earning assets -- on interest earning assets increased 70 basis points quarter-over-quarter resulting from the repricing of variable rate loans, as well as higher pricing on new loan production. However, this increase was offset by an 83 basis point increase in our average cost of deposits. The increase in our average cost of deposits was the result of the attrition that we experienced and non-interest bearing deposits in the quarter, combined with increases in the rates on all of our interest-bearing deposit categories. Moving forward, based on current expectations for interest rate movements, we expect our net interest margin will continue to be pressured in the first quarter of 2023, largely due to our expectation for rising deposit costs as maturing time deposits renew at higher rates and also due to our projection for higher average time deposit balances in the first quarter. Continued increases in loan yields are expected to offset some of the increase in deposit costs, but overall, we are expecting margin compression through the first half of 2023. The amount of compression will be dependent on a variety of factors relating to balance sheet composition as well as the interest rate environment. Moving onto Slide 7. Our new loan production in the fourth quarter was comprised of 65% variable rate loans and variable rate loans represented 46% of our total loan portfolio as of December 31st, 2022. Now moving onto Slide 8. Our non-interest income was $12.1 million for the fourth quarter, representing a decrease of 9% from the proceeding third quarter. The primary driver of this decrease was lower gains on sales of SBA loans attributed to a lower volume of loan sold, and a decreased in swap fee income. Additionally, we also realized gain of $375,000 from the sale of equity investments in the third quarter, which was not recurring in the fourth quarter. Moving onto non-interest expense on Slide 9. Our non-interest expense was $84.5 million, which was relatively consistent with the proceeding third quarter. We experienced a decrease in salaries and benefits expense, primarily resulting from lower incentive compensation expense. We also had a swing in OREO expense to OREO income largely reflecting fair value adjustments. These positive variances were offset by small increases in other areas of non-interest expense. Looking at the first quarter of 2023, non-interest expense is expected to trend higher due to projected increases in salaries and benefits, as well as earnings credit rates associated with certain segments of our deposit base. As a percentage of average assets, we expect our non-interest expense will remain in the current range of 1.79% to 1.81%. Now moving onto Slide 10, I will discuss deposit trends. Our total deposits increase 1.5% from the end of the prior quarter. The increase in deposits combined with a relatively flat loan portfolio reduced our net loan to deposit ratio to 97.2% at the end of the fourth quarter from 99.2% at the end of the proceeding quarter. We experienced a decreased and non-interest bearing deposits during the fourth quarter with nearly 40% of this decrease coming from our commercial depositors, moving their excess liquidity into interest bearing accounts. A portion of the outflow from non-interest bearing deposits can also be attributed to seasonal fluctuations that we typically see in the fourth quarter related to property tax payments and normal year-end trends in operating cash flows among some of our larger commercial depositors. To offset the decrease in non-interest bearing deposits and to improve our overall liquidity, we increased our balance of time deposits. Looking forward to 2023, we expect our non-interest bearing and core deposits will return to a more stable to growing trend as we make progress with deposit strategies that are currently being implemented. Now moving onto Slide 11, I will review our asset quality. We recognize positive trends across the portfolio in the fourth quarter. Total non-performing assets at December 31st, 2022, decreased 28% quarter-over-quarter to $69 million and reflected reductions in non-accrual lungs, delinquent loans 90 days or more on accrual status and accruing TDRs. At quarter-end, total non-performing assets represented just 36 basis points of total assets down from 51 basis points at the end of the third quarter. Total criticized and classified loans decreased by 8% in the fourth quarter. For the full year, total criticized and classified loans decreased by 48% due to two primary factors. First, we experienced steady improvement in asset quality as more borrowers demonstrated sustained improvement in their financial performance as they recovered from the impact of the pandemic. And secondly, we continued to be proactive in derisking the portfolio of loans that were deemed to be higher risk via loan sales. Overall, our loss experience remains relatively low. We had $6.4 million in net charge-offs during the fourth quarter or 17 basis points of average loans on an annualized basis. For the full year, we recognize net recoveries of $12.2 million. In the fourth quarter, we recorded a provision for credit losses of $8.2 million, which primarily reflects a decline in projected macroeconomic variables. At December 31st, 2022, our allowance for credit loss is coverage ratio represented 1.05% of total loans, while our coverage of non-performing assets increased to 234% from 166% at September 30th, 2022. Now moving onto Slide 12. Let me provide an update on our capital position and returns. With our solid financial performance, all of our capital ratios, with the exception of our Tier 1 leverage ratio, improved from the end of the prior quarter. Our tangible common equity to tangible asset ratio remained strong at 8.29% as of December 31st, 2022, up 20 basis points from September 30th. As announced yesterday, our Board of Directors declared a quarterly cash dividend of $0.14 per share, which remained the same as last quarter. During the quarter, we did not repurchase any stock and continued to have $35.3 million of our $50 million stock repurchase program available for future repurchases. Thank you, David. Now moving onto Slide 13. Let me briefly summarize our financial performance for 2022 versus the outlook that we initially provided a year ago. In terms of loan growth, we guided that our reenergized focus on business development was expected to lead to high single digit to low double-digit loan growth for 2022, excluding PPP. We achieved the higher end of our guidance with 12.2% loan growth excluding PPP. We initially guided for stable net interest margin for the beginning of the year and then revised to continued margin expansion for the second half of 2022 and flat to slight compression in the fourth quarter, potentially offsetting to a small degree year-to-date margin expansion. In 2022, we experienced margin expansion in the first three quarters of the year, which was partially offset by margin compression in the fourth quarter, aggregating to a 23 basis point increase in NIM for 2022. In terms of profitability, we guided for enhanced net interest income expansion driven by rising interest rates and earnings as asset growth in the range of 13% to 16% for the full year. We achieved the lower end of this guidance with net interest income in 2022, increasing by 13% over 2021. We said non-interest expense to average assets would range from 1.65% to 1.7% near-term, and later updated the guidance to 1.75% to 1.8% for the full year, and we achieved the middle range of this guidance with 1.78% non-interest expense to average assets for 2022. And finally, we projected that our criticized loan balances would trend down by approximately 20% to 30% by year-end. We basically achieved that by mid-year and revised this guidance to a reduction of 30% to 40% for the full year. We actually delivered a 48% reduction in total criticized loans from the year-end of 2021 to year-end of 2022. All-in-all, we delivered solid financial performance, which was consistent with our guidance, not withstanding the volatility that we all experienced in 2022 with the pace of interest rate hikes having been faster than at any time in recent history. Now moving onto Slide 14. I will wrap up with a few comments about our outlook and priorities for 2023. It is clear that 2023 will be a challenging year on numerous fronts. Given the current level of economic uncertainty, we will continue to maintain our selective approach to new loan production and continue to focus on generating higher yielding C&I loans that are more resistant to recessionary pressures. As with 2022, we expect our strengthened and expanded C&I lending capabilities will be a major driver of new loan production in 2023. With the larger contributions coming from the more recent additions that we have made to the corporate banking group and our increased presence in newer geographic markets, we are confident in our ability to generate strong loan production without compromising on our underwriting or pricing criteria. As a result, and while maintaining our cautious approach to new loan production in the current environment, we expect to generate loan growth in the mid single digits in 2023. This lower level of projected loan growth will also enable us to focus more heavily on building a lower cost stable core deposit base. The deposit strategies that we are implementing now are focused on further strengthening our retail foundation of individual and smaller business customers, as well as our larger corporate client base. However, for the near-term, we expect higher deposit costs will mitigate expansion of our net interest income. We anticipate that our net interest income for the full year of 2023 will increase modestly with higher cost of deposits and borrowings, offsetting in large part higher interest income from the growth in our earnings assets. We are also expecting the run rate of our non-interest income to trend lower in 2023 versus 2022 due to a reduction in net gains from SBA loan sales. While premiums available in the secondary markets have somewhat stabilized, we believe that maintaining a greater portion of these higher yielding assets in our portfolio, while interest rates remain at these high levels will add greater long-term value by way of interest income. Given the challenges of the current operating environment, we will also further strengthen our focus on disciplined expense controls, while we leverage the significant investments in talent and capabilities we have made in our franchise over the past few years. We are looking deeply across the organization and our branch network for opportunities to further enhance efficiencies, while at the same time strengthening our presence in targeted markets. While we are fully cognizant that 2023 will be a challenging year, we expect the pressures on our margins and profitability from the rising deposit costs will diminish as we progress through the year. As a result of the significant investments that we have made in our organization over the past few years, we are a much stronger and much more diversified franchise today than we have ever been. We believe we are well-positioned to effectively manage through economic downturns and build, show the value for the long-term. With that, we would be happy to take your questions and add any color -- additional color as requested. Operator, please open up the call. Hi, good morning. Maybe we could start -- maybe we just start on non-interest bearing deposits, the decline there. If you could just give us some additional color on what drove that decline? And I guess, what gives you confidence that you're going to be able to stabilize those balances, if not grow them this year? Well, the outflows of non-interest bearing deposits have very close relationship to the higher interest rates. The people are more sensitive to the earnings opportunity with their funds at the bank. So, there was a somewhat meaningful migration from the non-interest bearing deposits to interest-bearing deposits. But we believe much of the migration of those non-interest bearing deposits may have happened already with the expectation that interest rates are viewed to have reached its peak. So that's how I see the market as of today. Unfortunately, it's a function of what and when the Fed does with the rates then we do not have any control over the actions. So, we are just focusing on what we can do internally, and we are implementing a number of deposit initiatives focused both corporate and retail core deposits that we believe will help protect and strengthen our lower cost deposit base. So, there was nothing in there that was related to customers leaving the bank maybe that we might have been a little chunky. Okay, great. And then just on the interest-bearing deposit costs, we see the average for the quarter, but do you happen to have the end of the year kind of spot rate on either total deposits or interest-bearing? Okay, great. And then just last one from me on the net charge-offs this quarter. Can you just give us a sense for what drove that, if there was anything unusual there if that was kind of managing down criticized or if that's a more reasonable range going forward? Sure. This is Peter. Yes. The charge-offs this quarter were slightly elevated. We don't see any real systemic issues there. I think really just one-off cases. I think just part of our overall practice management to try to exit and resolve some of these loans. So, yeah, slightly elevated, but again, I think we're just one-offs. Great. Kevin, you talked about just the normalization of the mix of deposits getting back. Could you just provide a little bit more color? CD, I assume you're talking about just greater CD mix and perhaps a downward pressure on DDA, but any context of what you're modeling specifically to get to that slight growth in NII for the year. Maybe I can try to answer that. This is Peter. So, I think with that just overall deposit base because of the CDs, I think we had a high reliance on CDs in the fourth quarter. And as we look at some of our other opportunities and initiatives, I am seeing -- we are seeing a lot of opportunities in other areas as well. I think including non-interest bearing accounts with some of our existing customer base and also I think money market or savings accounts as well. So, we have a variety of different initiatives I believe that we can pursue this year that is a little bit different, I think, than what we just experienced, I think, in the fourth quarter where there was a heavy reliance on time deposits. Chris, if I may add, we do not view time deposits as our primary source of funding, obviously. And in the immediate quarter, as banks continue to compete for deposits, we expect continued inflows of our CDs into our mix. But we see opportunities to track lower cost core deposits. And eventually, we are really trying to help build our core deposit customer base for the long-term. So, as we go toward the end of 2023, I think, we have a much improved deposit mix. For the immediate term -- immediate near-term and quarters, we still expect to see inflows of our CD. Okay. Thanks, Kevin. The other question is on capital. I guess twofold question. Your stock sitting at tangible book. Obviously, the environment is uncertain. But thoughts on buybacks at or below tangible book. And also, can you remind us on your current thoughts on the convert that's going to get put to you later the mid of the spring? Okay. Chris, given the volatility in the market, we think it would be prudent to maintain a conservative stance on capital for the near-term. And I would expect that any activity related to our convertible notes should precede any other capital actions. And in terms of the convertible note, which we expect to be put by investors in May of this year, we have been very actively looking at various options to payoff that convertible notes. And we are currently in the final stages of our analysis. And I expect that we would be able to make an announcement closer to the end of the first quarter. Having said that, considering our current valuation in the market, I can assure you that we are very actively monitoring opportunities to reenter the buyback market. Okay. Okay. So, I guess, the range of outcomes for the convert would be replace it at a higher cost, potentially use excess cash, if you have any to paid off, that's kind of how you're thinking about the balance. Yeah. Well, we don't know. I think it is a little immature to share whether the convertible notes will be fully refinanced or we will just refinance a portion of that. Thanks. Good morning. Just wanted to ask about the expectations for, I guess, balance sheet growth in 2023. You talked about mid single digit loan growth. Wondering if there's a piece of that, that could be funded by securities, cash flows or cash on the balance sheet? Or do you expect that kind of balance sheet growth and deposit growth is pretty well mocked up with that loan growth over the course of the year? We plan to fund our loan -- new loan production mainly with our deposits. And obviously, we are currently seeing approximately $50 million per quarter of cash flow being generated from our investment portfolio, but we currently plan on 100% reinvestment back to the investment portfolio. So, we believe that mid-single digit loan growth will be funded by our deposit growth and our expectation for the deposit growth will be pretty comparable to our loan growth. Okay. And then I think a couple of times you have mentioned deposit strategies that you're implementing. Can you give us any more color on what you're doing there? Are they kind of business line oriented? Or is it just greater kind of pressure on loan customers to bring deposits over? Just some more color there. Thank you. Gary, this is Peter. Yeah. We would like to share more information. But I think for competitive reasons, we can't disclose too much. But I do just want to share we do have sort of a multi-prong approach to this. And I think the focus, as we mentioned before, really will be in terms of the core deposits. And so, I think every category that you see there that would be considered core deposits we are building and currently implementing strategies around those. Great. Thank you. Good morning everybody. Thanks for the opportunity to ask a question. Kevin, can you kind of provide some color on the pipeline that you're seeing right now? Yeah. Yeah. The pipeline for the first quarter of this year is down compared with the start of the fourth quarter of 2022, but I think that is normally expected due to seasonality factors. And the smaller pipeline is also due to the higher interest rate environment and the overall impact it has industry-wide on CRE loan demand. And in addition to that, given the looming recession, we are also exerting greater pricing and credit discipline as we continue to be more selective in our lending practice and favor businesses that are less impacted by consumer spending and a more recessionary resistant. So, pipeline is smaller and that is not really unexpected. Well, we are really trying to focus on customers who are more recession resistant. And so far we have not seen any significant impact to loan demand for those type of customers. But obviously, high interest rates will impact all areas of lending, and we are very cognizant of that. Thank you, Andrew. Once again, thank you all for joining us today. We hope everyone stays safe and healthy, and we look forward to speaking with you again next quarter. So long everyone.
EarningCall_1454
Good morning, and welcome to the Acuity Brands Fiscal 2023 First Quarter Earnings Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, the Company will conduct a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to Charlotte McLaughlin, Vice President of Investor Relations. Charlotte, please go ahead. Thank you, Crystal. Good morning, and welcome to the Acuity Brands fiscal 2023 first quarter earnings call. As a reminder, some of our comments today may be forward-looking statements based on our management's beliefs and assumptions, and information currently available to our management at this time. These beliefs are subject to known and unknown risks and uncertainties, many of which may be beyond our control, include those detailed in our periodic SEC filings. Please note that our Company's actual results may differ materially from those anticipated and we undertake no obligation to update these statements. Reconciliations of certain non-GAAP financial metrics and their corresponding GAAP measures are available in our 2023 first quarter earnings release, which is available on our Investor Relations website at www.investors.acuitybrands.com. With me this morning is Neil Ashe, our Chairman, President, and Chief Executive Officer, who will provide an update on our strategy and first quarter highlights, and Karen Holcom, our Senior Vice President and Chief Financial Officer, who will walk us through our financial performance. There will be an opportunity for Q&A at the end of this call. For those participating, please limit your remarks to one question and one follow-up, if necessary. We are webcasting today's conference call live. We delivered solid results in the first quarter of fiscal 2023, as we continue to demonstrate our ability to drive sales growth through product vitality and service in both our lighting and spaces businesses. We expanded adjusted operating profit, substantially grew adjusted diluted earnings per share, and generated strong cash flow from operations. We again created permanent shareholder value through share repurchases. Both our lighting and spaces businesses started the year with strong sales performance. First, in the Acuity Brands Lighting and Lighting Controls business. Our strategy of increasing product vitality and service levels continued to be a key differentiator for our customers. Our Contractor Select portfolio continues to be an excellent example of where these efforts are creating value. As a reminder, Contractor Select is a collection of the most important everyday lighting and lighting control products made up of a limited number of products with high product vitality and high service levels. This portfolio includes products from Lithonia Lighting, Juno, SensorSwitch and IOTA brands, and competes effectively in the electrical distributor and retail channels. An example of continued product vitality in the Contractor Select portfolio this quarter was the reintroduction of the upgraded DSX family of outdoor lighting. These products are used for commercial outdoor lighting as well as area lighting for schools, retail, and other everyday workspaces. The refresh focused on improving the design and increasing the control functions, including the ability to embed our nLight wireless controls. It is a significant step forward in enhancing our outdoor offering. Our focus on a concentrated offering with high product vitality and high service levels allows us to deliver high-end user satisfaction at attractive levels of profitability. Our product vitality strategy addresses several of our priorities, including our sustainability efforts. This quarter, in our A-Light brand, we launched a trio of sustainable products, lean, stitch and wings, that are marketed to office, commercial, and other similar customers. These products have a number of innovations, including collapsible designs and the use of new materials. For example, the materials in the wings products are 100% recyclable. Additionally, the collapsible design means the products contain less packaging waste and take-up less shipping space, which reduces the amount of fuel consumed during transportation as well as our shipping costs. The feedback on these products has been positive across the design and specification community and has been recognized. Our A-Light brand is leading by focusing on innovative design and sustainability, and I'm pleased to announce that this quarter our A-Light team won two GRANDS PRIX DU DESIGN Awards to celebrate the work of designers and architects who improve the quality of life and the built environment. We're also making progress on our strategy of improving service levels. We are beginning to satisfy more of our light backlog and decreased lead times as component availability becomes more stable. One of the core reasons our service continues to be differentiated is our manufacturing facilities in Mexico, not only are they strategically located, but they are also productive and very innovative. Our team of associates there is highly engaged and aligned to our values. I visited in December and I was impressed by the changes that they're making in staffing and employee engagement that will help us adapt to evolving market conditions. Finally, this quarter we took the decision to exit our Sunoptics Daylighting business, and our Winona custom architectural lighting solutions. These businesses were no longer strategically relevant and we do not expect them to meet our financial expectations in the future. We will continuously evaluate which businesses we operate and where we choose to compete. Karen will talk more about this in her comments. Now, moving to our Intelligent Spaces Group. The spaces team delivered good sales and operating profit growth this quarter. Both Distech and Atrius were successful in winning several new key customers and expanding services to existing customers. Our Distech product portfolio of controls and sensors is winning in the marketplace, largely in North America and France, and it has broader applicability. Therefore, we are focusing on increasing the addressable market for Distech. The first step is expanding the geographic markets that we serve. This effort is off to a promising start in the U.K. We are assembling the right group of independent systems integrators and are already delivering customer wins, including a large multi-million-dollar multi-year contract. In October, I was in Europe and had the opportunity to visit a large mixed-use construction site in Lyon, which was using a full suite of our Distech products to control the entire space. This installation is a great example of the power of a full Distech implementation with each VAC, lighting and shade control throughout all areas and for all tenants of the space. We look forward to continuing our market penetration in France, while we grow in the U.K. Moving to capital allocation. During the quarter, we repurchased just under 0.5 million shares, which brings the total amount repurchased since May of 2020 to just over 20% of our shares outstanding at an average price of approximately $140. Our capital allocation priorities remain the same. Our priorities are to invest for growth in our current businesses, invest in acquisitions, maintain our dividend and allocate capital for share repurchases when we perceive there is an opportunity to create permanent value for shareholders. Now, looking to the rest of fiscal 2023, there are two themes that we're focused on. First, there is obviously, uncertainty around the economy, inflation and interest rates, which we know will affect our business over-time. Second, we believe that as component availability improves, lead times will improve and backlog levels will return to normal. We are beginning to see this in our business. We are well-positioned in a variety of our end-markets and our continuing investment in-product vitality and service positions us well for these dynamic environments. Our organization continues to adapt to the changing requirements of our customers, and as a result, we have positioned ourselves not to predict the future perfectly, but rather to adapt to whatever comes our way. Finally, before I hand over to Karen, I want to congratulate our team on the accomplishments detailed in our 2022 EarthLIGHT report. Our products and services save our customers' energy and reduce their carbon emissions, and we are proud to announce our commitment to achieving net zero by 2040. As part of this, we've been working with the Science-Based Targets Initiative to establish new interim targets to further reduce our Scopes 1, 2, and 3 carbon emissions. This is both good for the environment and good for our business. Now, I'll turn the call over to Karen, who will update you on our first quarter performance and provide a strategic update. Our first quarter of 2023 was a solid start to the year. We delivered good sales growth and strong adjusted diluted EPS growth. We improved adjusted operating profit, grew cash flow from operations, and continue to allocate capital effectively. As Neil mentioned, during the first quarter of fiscal 2023, we took the opportunity to strategically review our portfolio and sold our Sunoptics business. This business provided dome skylights and smoke vents to several different types of commercial buildings. We also announced plans to discontinue our Winona custom architectural lighting solutions by the end of the fiscal year. As a result, we took non-recurring charges of $22 million or $0.52 per diluted share related to impairments, severance, accelerated amortization, and a loss on the sale of the Sunoptics business. In the first quarter, we generated net sales of approximately $1 billion, which was 8% higher than the prior year, largely due to price. Both the ABL and ISG businesses contributed to the growth during the quarter. Operating profit in the first quarter of $109 million and adjusted operating profit was $140 million. The higher adjusted operating profit was a result of a good gross profit performance, as we continue to manage price and costs. However, the fall-through of the higher sales to adjusted operating profit was lower because of the impact of strategic decisions made for fiscal 2023 around commissions. Finally, we continue to grow adjusted earnings per share. Our diluted earnings per share of $2.29 was a decrease of $0.17 or 7% year-over-year, as a result of the $0.52 of non-recurring charges I detailed before, while our adjusted diluted earnings per share of $3.29 increased $0.44 or 15% over the prior year. The growth in adjusted diluted earnings per share was due to higher operating profit, benefits from foreign currency, and lower shares outstanding due to the share repurchases. I now want to expand on our segment performance. Net sales of ABL grew to $947 million, an increase of 7% compared with the prior year. This increase was driven by higher year-over-year sales in our independent sales network, the direct channel, corporate accounts, and the retail channel. ABL's operating profit was $118 million, a decrease of $10 million versus the prior year with ABL adjusted operating profit relatively flat year-over-year. The lower fall-through rate was primarily the result of higher commissions, as I mentioned previously. Now, moving to ISG. The spaces segment had a strong quarter and improved both net sales and operating profit. Sales in the first quarter of 2023 were $57 million, an increase of $10 million or 22% versus the prior year. During the quarter, Distech had strong performance across a variety of projects and was able to work down a significant amount of backlog from the fourth quarter of fiscal 2022 as component availability improved. ISG's operating performance also improved due to the higher sales and benefits from the mix of products as we cleared some of that backlog. Operating profit in the first quarter of 2023 increased to $8 million this quarter. Now, moving to cash flow. We generated $187 million of cash flow from operating activities for the first three months of fiscal 2023, an increase of $103 million over the prior year's first quarter. As a reminder, last year, we invested in inventory in order to support our growth as well as insulate our production facilities from inconsistent supply availability with the intention of working down that inventory over several quarters, which we have done. We are now down 13 inventory days from the peak in February of 2022. We also invested $18 million in capital expenditures during the first quarter of fiscal 2023 and $78 million to repurchase approximately 0.5 million shares during the first quarter. Before I turn the call to the operator for questions, I want to reiterate the following. We are pleased with our performance in the first quarter of 2023. We delivered solid sales growth and strong adjusted diluted EPS. Our outlook for 2023 remains unchanged and we continue to position ourselves to quickly adapt to changing market conditions and to continue to allocate capital effectively. Maybe just on the backlog, Neil, it does sound like you made some progress kind of working that down. Any thoughts on kind of when you think the backlog returns to more of a normalized level? And I guess, on the supply chain, could you compare and contrast where the supply chain is performing today maybe relative to six to nine months ago? Yes, sure. So there's a fair amount to unpack there, Tim. Thanks for the question. So big picture, our expectation is that, as component availability becomes more consistent, and it is more consistent, although not yet back to normal, so it's - I don't think that the industry or we are completely out of the woods yet on that, but we are starting to see some more consistent availability, then that will enable us to reduce lead times, so that's a - that's obviously a positive. Along the way, we'll be working through that backlog. So as we've said over the last several quarters, and I would say the - your question implies probably pretty accurate, off the top of my head, probably second or third fiscal quarter of last year was when we peaked on our absolute level of backlog. And so we've been working down through that over the course of the last couple of quarters and we'll continue over the next quarter or two to be working through that. That should get us to a more normal relationship between order intake and lead times and net sales, which we think is the net - obviously, going to be a net positive. We don't know exactly how long that will take, so that's just an estimate, but that's - I think round numbers, that's about right. Okay. Okay, good. And then maybe, Karen, just on the commission comment. Could you elaborate, I guess, what exactly that was in the quarter? And I guess, if that's isolated to the fiscal quarter or is it just going to generally be a high-level of commissions for the year? Yes, thanks, Tim. There are several things going on in commissions this year, and what we're really focused on is investing in future business. So for example, we've made some investments and changes to our direct sales force commissions to position them for the upcoming future infrastructure business and we've also invested to secure certain project business. So I think what you'll see is that this is going to continue through the balance of the year at this level. Thank you. One moment for our next question, please. And our next question will come from Chris Snyder from UBS. Your line is open. Thank you. I wanted to start with one on capital allocation for Neil. In the past when you provided your framework, M&A always kind of came in above buybacks, but over the last year or two now, really all the capital has gone towards buybacks. And I think most of the great - with the multiples we've seen compress in the marketplace, if that was the right use of capital. But as we look forward here, can you talk about, is that starting to shift more in favor of M&A? Could you maybe talk about any sort of M&A pipeline. And then, specifically, the types of assets the Company is looking for. In the past, the Company - you've talked about maybe tech assets to build-out the ISG Group, but also may be looking at semi-adjacent industrial verticals to kind of deploy some of the software tech assets across. Thank you. Yes, thanks, Chris. So we've been consistent since I've been here about our priorities for capital allocation, we'll invest in our current businesses, we'll invest in M&A, we'll maintain our dividend and we'll use capital for share repurchases when we feel like there is an opportunity. So over the course of the last several years, obviously, our value has been less than the general market's value. It's created an opportunity for us, as I said in my comments, to repurchase over 20% of the Company at about a little less than $140 per share. So we feel really good about that capital allocation. The world, as you indicated, is starting to change and come back to us a little bit. So as valuations on other assets start to come back to more reasonable levels, then we do feel confident in our ability to deploy capital going forward. So the first thing that we did, obviously, was the OSRAM OPTOTRONIC's acquisition for our Lighting and Lighting Controls business, which allows us to control the technology and our luminaires to develop an OEM - a broader OEM channel and to take greater control of our electronics supply chain, which obviously has borne significant strategic fruit. So as we look forward, we have a pretty solid pipeline of interesting opportunities, most notably in areas where we can expand the addressable market of our Intelligent Spaces Group, and we're seeing acquisitions of all different sizes there. So we'll continue to evaluate, obviously, our ability to generate cash, which is significant. So we were very pleased with the operating cash flow this quarter, as Karen indicated, we're paying down the investment we've made in working capital last year, and that positions us with plenty of capital to meet all of our capital allocation priorities. Thank you for that. And then I just want to kind of follow-up on operating leverage. Can you just talk about the confidence in the ability to generate operating leverage as the environment starts to normalize? And the reason I ask is, this quarter, gross margin was flat year-on year and the company realized healthy high-single-digit growth, but operating margin was down year-on-year. I mean, I know investing in growth is a big priority. So just kind of, through this, any thoughts or confidence in the ability to generate operating leverage through the rest of the year or even through the following year. Thank you. Yes, we're confident in our ability to generate operating leverage. So as Karen indicated, and I'll elaborate a little bit, I think if you - when you see us over the course of time, so from 2020, '21, '22, '23 and beyond, and you would see a - and if you looked at that period in retrospect, you probably see, obviously, last year, we had a significant growth in net sales that was not - we did not grow margins quite as fast and you'll see us grow margins now as we start to bring those things together. So those haven't been perfectly synchronous, but we're generally pleased with the decisions we've made and our ability to take share. So now as our focus is on generating that margin and leverage going forward, as Karen indicated, we've made some investments in commissions kind of, anecdotally, we invested in hall of fame, so that they could be positioned to - for the infrastructure dollars that we expect to be coming. We've changed out a couple of our agencies, so we've talked about New York, and I think others have talked about Atlanta, as examples. So there are a series of these things, which add up to a net investment in commissions, but not a permanent change in the percentage of sales that we invest in commissions. Thank you. And one moment for our next question, please. And our next question will come from Joe O'Dea from Wells Fargo. Your line is open. I want to start - morning. Could you just help a little bit with the bridge from fourth quarter margins to first quarter margins, if we take it both from a gross margin and an SG&A approach. What it was that sort of led you to be able to achieve kind of flattish gross margin sequentially? And then similarly on the SG&A, is that all a function of commissions or anything else going on there? Yes, I'll start and then Karen keep me honest here. So sequentially, I think the - Joe, as you know, we have lower sales in the first quarter versus fourth quarter. So the ability to deliver consistent gross margin was a solid performance on the gross profit side. That was largely driven by two things, one is our ability to maintain price, and the second was our ability to maintain the levels of productivity in our own production facilities. And then on the operating expense side, as Karen has indicated, really the whole story has been commissions. So that relatively mild increase in investment in commissions is what has delivered the operating profit where it is. And as I said to Chris's, question, we're confident that, over time, we can leverage those expenses. Yes. And Joe, the only other thing I would add is, when you - when I mentioned ISG in my opening comments, they did have a really strong margin performance this quarter as - their electronic component availability improved and they were able to clear some of the backlog that really did result in some favorable margin for them. Got it. That's all helpful. And then on the demand environment. I know - just sort of days into the calendar flip. But I'm just curious is, you're seeing sort of supply-chain ease and maybe a little bit more comfort out there, and at the same time, some of the macro uncertainty that you touched on, just as we think about sort of cadence over the last few months, anything you're seeing in terms of sort of shifts in demand, whether you're seeing a little bit more caution and wait-and-see. Obviously, we see kind of the ABI over the past couple of months, but sort of what you're tracking on the most real-time on the demand front? Yes, so Joe, I'll start and Karen add to anything that you want to on this. So obviously, we're focused on the economy, so inflation, the Fed interest rates, et cetera. And we, obviously, don't have a crystal ball better than the market, so we're paying attention to that. As I indicated, there's two other things that we are paying a lot of attention to. The first is that, as component availability, as you indicated supply chain, there will be - we will start to be able to return to more normal lead times, and so that transition will impact - probably impact demand for a short period of time as we work through where people have probably bought ahead a little bit, so that they could ensure that they have availability. An example of that would be distributors that would have stage in-store inventory in their inventory. So that would be where contractor or a distributor or project would have bought earlier than normal on their Lighting and Lighting Controls, and they would have done that for any number of reasons, but the two most obvious would be to ensure that they have the product when they needed it, number one, and two, they might have bought ahead of some price increases as their - so that they could capitalize on those lower prices. So we expect that to - the combination of those things to impact demand over - kind of over the next several periods. We don't know exactly how much and when, but we expect those to affect us. But net-net, we're confident in our ability to continue to take share in the industry and our - through our product vitality and our service levels, which are tools that we did not have in our toolkit the last time we faced an economic environment like this. Thank you. One moment for our next question, please. And our next question will come from Christopher Glynn from Oppenheimer. Your line is open. Thanks. Happy Monday, everybody. So on the improving lead times and getting some backlog out. Karen did a little bit of drill down into ISG with the margins there. Curious, as pertains to ABL, are you seeing a pathway to have more predictable level loading of the factories that might be a little gross margin opportunity as the year goes on? Yes, thanks, Chris. It's Happy Monday and Oxymoron, so I wanted to check, and thank you all for showing up at 8 o'clock on a Monday for this call. Big picture, yes, we are moving - we are trying to move towards more level loading of our facilities on the ABL side. So to take two steps back on the electronic component supply. So obviously, and I mentioned earlier, we bought OSRAM now - I referred to as OPTOTRONIC for three reasons, one, to control the technology in our luminaires, the second, to expand our exposure to the OEM market, and the third is to take greater control of our supply chain. So over the course of the last year when the - kind of the market was - when we had just bought it and the market was bouncing around, we prioritized OEMs so that we could demonstrate to the market that they were - we were serious about being in that business. We believe that, as we go forward, we have now have the opportunity to take greater control of that electronic supply chain. So that is, obviously, the pacemaker items have been on the electronic component driver side. So as we start to take more control over that, we think we will have more control and the ability to have greater level loading over time. The level loading won't be perfect, obviously, because that'll be balanced by lower absolute levels of backlog as we lower lead-time to get more - in a more normal operating rhythm. But yes, we believe that, net-net, we are in a position to better level load our facilities going forward and be us taking greater control of our electronic supply chain. Great. Thanks. And on the follow-up, it's pertains to Sunoptics and some of the Winona discontinues. What's the associated revenue and cost savings with those? And should we be considering those in our annual model or does it just kind of dovetail with the guidance framework that you laid out last quarter and reiterated by reference today? Yes, let me just take a - put this in context first and then Karen you can answer the specifics on the financials. We do want to get in front of changes that we see in the marketplace. And so we are going to constantly evaluate the businesses that we compete in, and Sunoptics was an acquisition from about 2013 or so I think that just frankly wasn't performing anymore, and our Winona custom business was just that, a custom business that we didn't expect to perform in the upcoming environment. But these are also demonstrations of our willingness and ability to make decisions that we think are going to impact the business going forward. Each of these were - so we will absorb the impact of these in our guidance both to top line and the profitability going forward, and that was contemplated, obviously, in our - in Karen's comments about this year. Thank you. One moment for our next question, please. And our next question will come from Ryan Merkel from William Blair. Your line is open. Thanks. Good morning, and thanks for taking the questions. I just had a couple of follow-ups. My first question is on gross margin. Is the shape of gross margins it's still the same where the second half is going to be better than the first half or has that changed because componentry is a little bit easier to get? Yes, Ryan, when we talked last quarter, we did talk about some of the pressures that we would see and some of the higher cost inventory started to flow through in the first half of the year. So that really hasn't changed. Our perspective is that inventory will continue to flow through in the first half of the year. And so that should indicate some opportunity for improvement in the back half, as well as to what Neil mentioned earlier with the opportunity more level loading of our facilities and to have more control over the electronics in our supply chain. Got it. Okay. And then a follow-up on SG&A. I think you said you're going to leverage SG&A this year. When do you expect to do that? Does that happen in 2Q? And can you just unpack what changes from 1Q? I'm not sure I heard that. Thank you. Yes. So thanks for the opportunity to clarify that because that's not what I said. Chris' question, I think, was, are we confident that we can leverage SG&A? And yes, we are confident that we can leverage SG&A. The change in the first quarter sequentially from the fourth quarter in the SG&A number was primarily around the investment and commissions that Karen outlined. So we see those commissions. We expect those commission investments to continue through the next couple of quarters in relation to sales. So don't expect us to leverage that line. Obviously, we will constantly be evaluating our operating expenses and especially if the market changes. But all of that's contemplated in the guidance that Karen provided. Thank you. One moment for our next question, please. And our next question will come from Jeffrey Sprague from Vertical Research Partners. Your line is open. Thank you. Good morning, everyone. I guess maybe next Monday will be Happy Monday roll off for MLK Day. So I feel like we're beating a dead horse with this commission question, but I'm a little bit confused here. It sounds like you're paying higher commissions today for potentially better sales in some future period. Is something else going on here, which is kind of the ability to retain salespeople or kind of just labor costs, labor availability, - and why would you be kind of front loading commission costs for this potential future infrastructure revenues and the like? Yes. So let me be a little bit more granular, Jeff, which I think will give you some more insight and color. So on the infrastructure side, we're evolving how we take holiday to market with our direct sales and some agency relationships. So in some cases, we're paying double - we're paying double commissions on existing business. We will work through that over time so that, that will return to a more normal level. And second, as we indicated earlier, as we make sometimes some changes in markets like New York, which we've talked about or Atlanta or others around the country, we incur some period costs as we make those transitions that show up in the commissions line. Understood. Thanks. And then just on Distech, the international opportunities that appear to be unfolding, can you just give me a sense of kind of the total footprint? Is it now just U.K. and France and Europe? Are you looking at other markets? Maybe just give us a sense of kind of the plan there? Maybe it's kind of a two or three year plan, it sounds like, but to roll that out more broadly? Yes. Thanks for the question. So Distech is a very attractive business. So they have the best technology in the market. They compete effectively on the building management control sensor market. And it's largely been focused on North America and France. So we have good penetration in France. We have developing penetration in the U.S. And, yes, the technology is applicable in multiple markets. And so it is a multiyear strategy. So first is the U.K. The second will be to start to grow. We have a very small business, but we have - we'll have a developing business in non-China Asia, which we think provides a large opportunity. So net-net, we think we can continue to push this geographic expansion. And the theme around Distech will be, we do have a better mousetrap so now we want to increase the addressable market. Thank you. One moment for our next question, please. And our next question will come from Brian Lee from Goldman Sachs. Your line is open. Hi, everyone. Good morning. Happy New Year. Maybe just zooming out a little bit at a couple of bigger picture questions. I know you don't like to talk about price too granularly, but you've mentioned over the course of the past several quarters, including earlier today that price increases have been a tailwind, and you've had multiple price increases, obviously, in the past year. Any sense just kind of, again, big picture, what the outlook is for pricing given input costs, freight? They seem to be coming back in now. Any feedback from customers and/or peers around whether you'd expect some level of price to give back here through 2023? Yes. So, Brian, big picture on price. Over the course of the last couple of years, we've done several things, which will ultimately impact price. The first is to dramatically increase our product vitality. So we're delivering better value through our products to our end users through productivity in those products and the relationship between what they're getting and what they're paying for it. The second is that we've been strategic about our pricing. We price based on market conditions so that we can compete effectively in everyday products, and we can win the projects that we like to win. That combination of product vitality, having the right product at the right price, at the right value for customers, and our ability to manage price strategically has been what has allowed us to deliver the results in the past market that we've encountered. We think those tools are really valuable in the market that we expect to encounter going forward. So having the kind of the best products at the right price in the right place, the ability to make margin when we do that and the ability to price strategically based on a difference between, say, everyday products and choosing, which projects we want to win is really valuable going forward. Okay. Fair enough. All makes sense. And then I guess maybe related to that a little bit, just China reopening, again, the comment around freight costs starting to normalize. Any updated thoughts on just sort of the competitive landscape, especially from overseas suppliers? Yes. No, it's always a good question, and we have tremendous respect for competition. We consider competition as a gift. Having said that, just to reiterate, about 20% of our product is sourced from Asia, about 60% is manufactured in North America, as I indicated, Mexico, the U.S. and Canada. So - or 60% in Canada and 20% in the U.S. So what that allows us to do is compete effectively with whoever the new competitors are. So just like everyone else, we've dealt with challenges getting our products out of Asia and here. So net-net, while we expect there to - on the margin be a little bit more competition, obviously, we've been competing effectively in the same market they have. Thank you. And I'm showing no further questions in the queue at this time. I'd like to turn the call back to Neil Ashe for any closing remarks. First of all, thank you all for joining us. As we indicated early on a Monday morning we are pleased with our performance in the first quarter. We had solid results. We're well positioned in our end-user markets, both on the lighting and lighting control side and increasingly on the Intelligent Spaces side where we're working to expand our addressable market. We expect the kind of the continuation of the current trends in the economy, and we're pleased with our ability to be adaptable to whatever the market sends our way. So with that, we'll send you on your way. And we hope you have a great rest of your day, and we look forward to talking to you again soon. Thank you. This concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day.
EarningCall_1455
Ladies and gentlemen, thank you for standing by. Welcome to the Third Quarter Fiscal year 2023 CarMax Earnings Release Conference Call. At this time, all participants are a in listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, David Lowenstein, AVP Investor Relations. Please go ahead. Thank you, Ashley. Good morning, everyone. Thank you for joining our fiscal 2023 third quarter earnings conference call. I'm here today with Bill Nash, our President and CEO; Enrique Mayor-Mora, our Executive Vice President and CFO; and Jon Daniels, our Senior Vice President, CarMax Auto Finance Operations. Let me remind you, our statements today that are not statements of historical fact, including statements regarding the company's future business plans, prospects and financial performance are forward-looking statements we make pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are based on our current knowledge, expectations, and assumptions, and are subject to substantial risks and uncertainties that could cause the actual results to differ materially from our expectations. In providing projections and other forward-looking statements, we disclaim any intent or obligation to update them. For additional information on important factors that could affect these expectations, please see our Form 8-K, filed with the SEC, this morning, and our annual report on Form 10-K for the fiscal year ended February 28, 2022, previously filed with the SEC. Should you have any follow-up questions after the call, please feel free to contact our Investor Relations department at 804-747-0422 extension 7865. Lastly, let me thank you in advance for asking only one question and getting back in the queue for more follow-ups. Bill? Our third quarter results reflect the continuation of widespread pressures across the used car industry. Vehicle affordability remain challenging due to macro factors stemming from broad inflation, climbing interest rates, and continued low consumer confidence. In addition, persistent and steep depreciation impacted wholesale values throughout the quarter. In response, we have been taking deliberate steps to support our business for both the short-term and for the long run. We are leveraging our strongest assets, our associates, our experience and our culture to manage through this cycle. Actions that we took during the quarter include further reducing SG&A, selling a higher mix of older lower priced vehicles, slowing buys in light of the steep market depreciation, maintaining used saleable inventory units while driving down total inventory dollars more than 25% year-over-year, raising caps consumer rates to help offset rising cost of funds, pausing share buyback to give us capital flexibility and slowing our planned store growth for next fiscal year to five locations while maintaining our ability to open more locations if market conditions change. In the near-term, we are prioritizing initiatives that unlock operational efficiencies and create better experiences for our associates and our customers. While we continue to selectively invest in initiatives that have the potential to activate new capabilities, we have slowed the pace of those investments. We believe these steps will enable us to come out of this cycle leaner and more effective while positioning us for future growth. We will provide more details on these actions later during today's call. And now on to our results. For the third quarter of FY ‘23, our diversified business model delivered total sales of $6.5 billion, down 24% compared with last year's third quarter, driven by lower retail and wholesale volume. In our retail business, total unit sales in the third quarter declined 20.8% and used unit comps were down 22.4% versus the third quarter last year, when we achieved a 15.8% used unit comp. In addition to the macro factors that I mentioned previously, we believe our performance was impacted by transitory competitive responses to the current environment. External title data indicates that we gained market share on a year-to-date basis through October, though we've seen some recent loss of share. As we have said before, we are focused on profitable market share gains that can be sustained for the long-term. Through expansive price elasticity testing, we determined that holding margins during the quarter was the right profitability play. Third quarter retail gross profit per used unit was $2,237, which is consistent with last year's third quarter. Also unit sales were down 36.7% versus the third quarter last year, driven by rapidly changing market conditions, which included about $2,000 of depreciation. This is incremental to approximately $2,500 of depreciation experienced during the second quarter. Wholesale performance was also impacted as we continued to reallocate some older vehicles from wholesale to retail to meet consumer demand for lower priced vehicles. Also, gross profit per unit was $966, down from a third quarter record of $1,131 a year ago. Recall, last year prices appreciated approximately $2,500 during the quarter, which was a margin tailwind. Just as we were doing in retail, we will continue to focus on maximizing total wholesale margin profitability. We bought approximately 238,000 vehicles from consumers and dealers during the third quarter, down 40% versus last year's period. Our volume was impacted by steep depreciation and our deliberate decision to slow buys in reaction to the depreciation. We purchased approximately 224,000 cars from consumers in the quarter with about half of those buys coming through our online instant appraisal experience. We also sourced about 14,000 vehicles through Max offer, our digital appraisal product for dealers, up 16% from last year's third quarter. Our self-sufficiency remained above 70% during the quarter. In regard to our third quarter online metrics, approximately 12% of retail unit sales were online, up from 9% in the prior year's quarter. Approximately 52% of retail unit sales were Omni sales this quarter, down from 57% in the prior year's quarter. Our wholesale auctions remained virtual, so 100% wholesale sales, which represent 18% of total revenue, are considered online transactions. Total revenue resulting from online transactions was approximately 28%, down from 30% during last year's third quarter. CarMax Auto Financer Cap delivered income of $152 million, down from $166 million during the same period last year. John will provide more detail on consumer financing, the loan loss provision, and cash contribution in a few moments. At this point, I'd like to turn the call over to Enrique who will provide more information on our third quarter financial performance and the steps we've taken to further align our business to the current sales environment. Enrique? Third quarter net earnings per diluted share was $0.24, down from $1.63 a year ago. Total gross profit was $577 million, down 31% from last year's third quarter. Used retail margin of $403 million and wholesale vehicle margin of $115 million declined 21% and 46%, respectively. The year-over-year decreases were driven by lower volume across used and wholesale and lower wholesale margin per unit. As Bill noted, we continue to face depreciation and have been adjusting accordingly to better position ourselves to manage through the current environment. Other gross profit was $59 million, down 49% from last year's third quarter. This decrease was driven primarily by the effect of lower retail unit sales on service and EPP. Service results declined $37 million has lower sales and secondarily, our decision to maintain technician staffing levels drove some deleveraging. Technicians are among the most in-demand associates in the industry, and their retention will position us strongly to quickly grow inventory when we exit the current cycle. EPP fell by 14% or $15 million, reflecting the decline in sales that was partially offset by stronger margins and a favorable year-over-year returned reserve adjustment. Penetration was stable at approximately 60%. Third-party finance fees were relatively flat over last year's third quarter with lower volume and fee generating Tier-2 offset by lower Tier-3 volumes for which we pay a fee. On the SG&A front, expenses for the third quarter were $592 million, up 3% from the prior year's quarter, reflecting a slowdown from the year-over-year increases of 19% during the first quarter and 16% during the second quarter of this year. In the prior year's third quarter, we received a $23 million settlement from a class action lawsuit. Adjusting for that settlement, SG&A actually would have declined 1% year-over-year this quarter. SG&A as a percent of gross profit was materially pressured as compared to the third quarter last year, due primarily to the 31% decrease in total gross margin dollars compared to last year's quarter. The change in SG&A dollars over last year was mainly due to the following factors. First, a $41 million increase in other overhead primarily driven by cycling over last year's legal settlement. We also continue to invest, although at a reduced pace in our technology platforms and strategic and growth initiatives. Second, an $18 million reduction in compensation and benefits, including a $16 million decrease in share-based compensation, and third, a $17 million reduction in advertising. During the quarter, we continue to take steps to better align our expenses to our sales. This included further reducing staffing through attrition in our stores and CECs limiting hiring and contractor utilization in our corporate offices and continuing to align our marketing spend to sales. While our advertising expense was lower year-over-year, our investment on a per unit basis remains consistent with last year's third quarter. We remain focused on reducing expenses and anticipate continued progress in the fourth quarter. Regarding capital structure, our first priority is to fund the business. Given third quarter performance and continued market uncertainties, we are taking a conservative approach to our capital structure. While our adjusted debt-to-capital ratio was below 35% to 45% targeted range. We are managing our net leverage to maintain the flexibility that allows us to efficiently access the capital markets for both CAF and CarMax as a whole. In keeping with this goal of maintaining flexibility, we took the following steps this quarter in addition to the SG&A actions I spoke to. First, we paused our share buybacks. Our $2.45 billion authorization remains in place, as does our commitment to return capital back to shareholders over time. Second, we slowed the velocity of our CapEx spend, we expect CapEx will end the fiscal year at approximately $450 million versus our previous $500 million estimate. As Bill mentioned, we have also conservatively planned store growth of five new locations in fiscal year 2024. Our liquidity remains very strong. We ended the quarter with over $680 million in cash on the balance sheet and no draw on our $2 billion revolver. In the third quarter, the strength and stability of our credit platform provided approvals to over 95% of the consumers who applied for credit during their shopping journey. CarMax Auto Finance originated $2.1 billion within the quarter, resulting in a penetration of 44.4% net three-day payoffs up from 42.2% realized in the same quarter last year and 41.2% in Q2. The weighted average contract rate charged to new customers was 9.8%, which was higher than the 8.3% in last year's third quarter and a 9.4% seen in Q2. We continue to leverage our scalable testing environments and nimble underwriting infrastructure to strategically pass along a portion of the increased funding costs to consumers while still increasing share of the finance contracts. Tier-2 penetration in the quarter was 20.5% in line with historical levels, but down from last year's 22.2%. Tier-3 have financed 6.1% of used unit sales compared to 6.5% a year ago. Our lenders continued to make their own independent lending decisions in this challenging environment, and we remain pleased with the competitive offers they are collectively able to provide to our customers. CAF income for the quarter was $152 million, a decrease of 8.3% or $14 million from the same period last year. Our loan loss provision was $86 million, resulting in an ending reserve balance of $491 million. This is compared to a provision of $76 million in last year's Q3. The current quarter's reserve of $491 million is 2.95% of managed receivables up slightly from 2.92% at the end of this year second quarter. This sequential three basis point adjustment in reserves to receivables ratio, comes primarily from the continued addition of Tier-2 and Tier-3 receivables to the overall portfolio as seen in previous quarters. All in all, we were pleased with the credit performance within our portfolio during the quarter, we believe we are appropriately reserved for future losses. Further, we continue to be in a strong position to leverage our unique credit platforms to operate our Tier-1 business within our targeted loss range up 2% to 2.5%. Within the quarter, total interest margin dollars were flat to last year at $277 million modestly supported by a $5 million benefit from our hedging strategy. The corresponding margin to receivables rate 6.7% was down 54 basis points year-over-year as receivables with historically low funding costs are offset by the receivables impacted by the more recent Fed moves. Regarding advancements in our broader credit technology, during the third quarter, we successfully completed the nationwide rollout of finance-based shopping, our multilinear pre-qualification product, and we continue to see a high level of engagement with this experience. As a reminder, this gives customers the ability to digitally receive quick credit decisions across our entire inventory be our simple online application with no impact to credit scores. This also allows consumers to quickly and easily secure financing at any point in their shopping journey. Like the rest of the business, CAF is also focused on driving efficiencies. We are already seeing benefits from the modern, more nimble receivable servicing system that we launched a year ago. Consumer finance is a highly regulated and everchanging space. And our new system allows us to adapt more easily to these necessary changes. A recent example is California's upcoming regulatory change that requires added disclosure and refund requirements related to the cancellation of the GAP waiver product. With our old system, the implementation would have been lengthy and onerous, and we likely would have temporarily suspended the product in the state while we made the changes. However, with our new more agile technology, we are able to incorporate these requirements without interrupting. This is just one example of our early wins resulting from our new system, and we have a clear line of sight to many more in the near and midterm. As I mentioned at the start of today's call, we're taking steps to support our business by prioritizing projects that unlock operating efficiencies and create better experiences for our associates and customers. It starts with making our omni-channel experience faster, simpler and more seamless. Some examples include, we're enhancing online features to help customers feel more confident in completing key transaction steps on their own and make it easier to go back and forth between assisted help and self-progression. We're also making it simple for consumers to opt into express pickup through self-progression. This delivery option offers customers the ability to complete their transaction at one of our stores in as little as 30 minutes and represents a win-win opportunity. Our research shows that customers love this experience when utilized and it will enable us to lower our costs over time. Our final example is that we are working to seamlessly integrate our finance base shopping product into our stores and customer experience centers so that all consumers can enjoy this experience, not just those who shop online. At the same time, we are adding additional lenders to the platform to expand the breadth and depth of offers available to our customers. As we evolve our omni-channel experience, we are also updating our operating models to drive efficiency gains in our stores. For example, in our business offices, we have launched self-check-in capabilities for appraisal customers and have also enhanced e-sign functionality to better enable self-progression. Additionally, we are testing an improved digital customer queue to better manage appointments, as well as new software to improve title speed and visibility. We anticipate these tools will enable us to reduce associate time spent per customer and shorten customer transaction times. Our associates are key to providing an exceptional customer experience and we are focused on leveraging their skills in the most value-added manner. We will also continue to selectively invest in key projects that have the potential to deliver new capabilities while lowering our costs. Examples include first, we're updating Max offer our appraisal product for dealers, which is available in approximately 50 markets. Many of our dealers are still on the initial version, which does not provide instant offers and requires them to take and send us vehicle pictures. We are rolling out a new product which offers a fully digital instant offer experience to all dealers. We believe this will well position us to grow our dealer, dealer buys more efficiently and support higher volume over time. Second, we are leveraging technology to enhance our logistics capability. We move approximately 2 million vehicles each year. We estimate that our internal logistics operation drives about a 20% cost advantage over third-party providers and improves our speed, predictability and control of moves. Enhancements to our transportation management system will enable us to consolidate loads, increase our mix of full loads and reduce the truck volume in and out of our stores. This will support our ability to keep our costs low as we complete moves even faster and more efficiently. Third, we're continuing to upgrade our auction experience. During the third quarter, we scaled our modernized vehicle detail page to 50% of dealers. This page is mobile friendly provides more relevant data to our dealers, and improved search and filter functionality. It is also the springboard that we will use to launch capabilities we believe will further enhance our wholesale business, including AI enhanced condition reports and proxy bidding. We are confident that our focus initiatives will drive efficiencies and grow our business over the long-term. In closing, we have spent almost 30 years building a diversified business that can profitably navigate the ups and downs of the used car industry. We have a strong balance sheet and access to capital. Our experience in inventory and margin management is a strength and we will continue to be thoughtful and manage our expenses pulling levers as necessary. While we're not able to predict how long the industry will remain challenged, we believe the pressures are transitory and that we are well positioned to manage through them and emerge an even stronger company. I want to thank our associates for everything that they're doing to support each other, our customers and our business, our foundation remains strong, and we're excited about the future of our diversified business model. So I guess the question I have just with regard to sales. And maybe Bill, if you could discuss a bit more just this trend of sales through the quarters, we understand better, how the business is performing here. And then also, you mentioned in your comments that you saw market share declines, if you will, I guess later in the period. It sounds like that was a result of others taking more aggressive actions on price. You can elaborate further there. Who's doing what, what cohort of your competition is doing that? And how long should it -- how long would you expect that dynamic to persist? And then, I guess a follow up to that, as you look at your business and CarMax has historically been very, very good at managing inventories. But you're starting to see now others take more aggressive action on price, and you've held the wider margin. Could there be percolating issues within your inventory? All right. There's a lot in there, Brian. So let me start with sales during the quarter. The last time we spoke, it was middle of September, latter part of September, we talked about sales being down in the mid-teens, it actually got a little softer by the end of September and it continued. We continue to see even more softness in October and November. I'll save you from having to get back into the queue because I'm sure your next question is, well, how's December panning out? December is actually running about where the quarter -- the third quarter ran on average. So it's a little bit better than November. But I would just remind you that we're also going to be -- we're comping over a little bit of easier performance, obviously, than we were from the third quarter that we will be doing in the fourth quarter. As far as market share, giving you some detail on market share declines. Year-to-date, like you said, we've still got -- we still have gains in share. We did see declines most recently in September and October, which is the latest title data that we have. But this speaks to -- I always hesitate talking about market share on the short-term basis because sometimes there are some temporary pressures. And we saw competitors lowering prices and margins to move inventory, which I'll be honest, it's not surprising. I mean, we saw a very similar play back in '08, '09 recession. It's also the reason that we did much more expansive pricing elasticity testing. And through those tests, we're confident that even though we would have sold more cars if we had lowered the prices, we actually would have made -- we made less money. And as I said in my opening remarks, and what I've always says we're always, what we're going after is profitable on a long-term market share gains, and I think we've got a great track record on that. I think your other question was just who's getting that look. This is a highly dispersed business lots and lots of players out there. I can't point to any of them. I just know that widespread pressures of folks trying to move their inventory and get rid of it. Maybe, first thing just on retail GPU, obviously, very well managed, again, this quarter. You talked about the fact that you're not discounting as much as some of your competitors. But at some point, you have to move the inventory that you have, it seems like it's aging -- and it's getting older on the lot. So like what gives ultimately, I mean, what do you have to consider the discounting at some point to move that inventory out the door, if not this quarter, maybe the next quarter? So how do you manage that transition? And how should we think about implications to retail GPU maybe in the next quarter or two through that pricing position? And I have a follow-up. Thanks. So, Rajat great question. This is where I think we really shine when it comes to inventory management, I'm really pleased. If you notice, I talked about how much our total inventory has gone down, but we were able to maintain saleable units. And that's because the team did a phenomenal job, really cleaning up stuff that we had, whether we’re waiting on parts, missing titles, we really worked hard to clean up a lot. So to your point, the aging inventory, it's one of the reasons why you didn't see more movement in our ASPs. Our average selling price is given the depreciation, the team did a phenomenal job working through that getting it out there. And then with our sophisticated price testing, we just realized, look, there's no sense and given this away. And so again, we feel like we put ourselves in really good position going forward. And I think what you'll see going forward is, your retail average selling prices are going to come down a lot more than what you've seen up to this point. So we feel good about retail GPU. Obviously, we will continue to test the elasticity as we go forward. But if elasticity holds, I think you'll see us continue to have robust retail GPUs. Got it. And maybe like, the other gross profit line, if I look at the volume that you did three years ago, very similar to the volumes that you have today, really slightly lower today. And that other gross profit was $94 million and now $59 million, despite your third-party financing fee is actually better. So why is that like down almost 50% on a similar level of volume? I mean, is there any opportunity to reduce the cost there. And I know, you mentioned that you want to retain the technicians, but how long are we going to see this kind of run rate before it can recouple to what you had in the past? And thanks for taking the question. Yes, specifically with the other margin, what you really need to do is look within the service business, and this quarter a couple of things. Number one was just with sales volumes being where they were down 20% year-over-year, that places a fair bit of deleverage pressure on the service business. That's number one. But number two, have almost equal importance this quarter, about $15 million year-over-year was our decision, the correct decision is to hold on to technicians. It's a very difficult position to staff, it is that most important that we retain, and we recruit the technicians because when we come out of this cycle, we want to be in a position where we can actually ramp up our inventory quickly, faster than our competitors. But that being said, it is an investment that flows through that service line. And again, this quarter was roughly $15 million given the current sales levels, but it's absolutely the right decision for the medium-term and definitely for the longer-term. That was the biggest pressure this quarter, Rajat. Yes. Rajat, the only thing I would add is, obviously, you're comparing it to a few years ago, we have a lot more production capacity now, because we have more technicians, we have more space. So that's feeding into it as well. Sorry, just a follow-up. What's your view on the cycle recovery? I mean, like, are you anticipating things like rebound at some point next year? Or I mean, what kind of conviction do you have on that like, just so that you might have to take some of these kind of actions, more aggressively? Just curious on the thought process there. Yes. Look Rajat, your guess as far as what's going to happen next year as good as mine. I think what we're trying to do is put ourselves in a position that regardless of what happens in the upcoming quarters, will flex up or if we need to pull additional levers will pull additional levers. So we're just trying to give ourselves flexibility at this point. Yes. I mean, we are laser focused on what we can control. And that's what we're taking actions on. And so you can take a look at our SG&A and how we've bent the curve there. You can take a look at service, yes, it's up. But again, there's -- the reason it's up is, that we're investing in our technicians, because we know that we're going to get through this cycle. And when we emerge from that, we want to be in a really strong position to reduce cars quickly. Just wanted to ask for a little bit more color on the SG&A cadence. I appreciate the comp cadence, but I was just wondering if you could help us think about the actions you took in Q3. And maybe the run rates and really, I don't know if we can think about an SG&A to gross kind of level for the next couple of quarters, or just help us understand kind of, what might be reasonable for you guys, just because there's been a lot of growth SG&A. And now it sounds like you're calibrating that. So anything you could provide there would be helpful? Yes, great. Thank you, John. Yes, like I said, in my prepared remarks, we have significantly bent the curve on our SG&A go back to the first half of the year as a whole, it was up 16% to 17% year-over-year. We've bend that down to 3%, year-over-year growth this quarter. But again, when you back out the $23 million settlement that we received last year in the third quarter, you're really looking at a slight decrease in overall SG&A. So pretty material change in the curve. We would expect that to carry forward into the fourth quarter and into next year. And why is that? It's because it's the actions we've been talking about, right. And that's really kind of two groups of actions. Number one is on the more variable perspective, we've been lowering our headcount, lowering our staffing, from an attrition basis in our stores. So that actually takes a little bit more time, right, because you're managing it through attrition, but we believe it's the right thing to do from a culture standpoint. And that has been bleeding down really, since the second quarter, when we started talking about it, we expect that'll carry forward to the fourth quarter and into next year. The second piece is really taking a look at our fixed costs and actively managing there as well. So I've talked about looking at our uses of -- our usage of contractors in the corporate home office, we've pulled back there, right. And we've also essentially paused our hiring in the corporate office. We are still hiring backfills and key positions that we have as well, kind of strategic positions as well, by materially, so we've kind of paused our corporate overhead hiring as well. So we've taken strong actions, we believe they're appropriate actions for the marketplace that we're operating in. If we need to take further actions, we would do that as well, if required, but we believe we're strongly positioned right now. And to answer your question about like the cadence, I would expect the fourth quarter to look similar to the third quarter once you back out the settlement from last year. And when you say relatively similar to the Q3, would that be in terms of dollars, or would that be in terms of SG&A to gross? Yes. So it's more of a year-over-year SG&A and how that's moving, it's not to grow? So I think the challenge, John with the leverage ratio, the SG&A to gross profit is we can control SG&A. And I believe we've been doing that effectively. The challenge is the gross profit number. So depending on where that gross profit number ends up and sharp movements, quarter-to-quarter make it really difficult to manage that leverage ratio. So in terms of, as I mentioned earlier, we'll control what we can control. And that's what we're focused on. We're focused on that SG&A line. So I would -- my comments are specifically about SG&A growth year-over-year and the quarter. Perfect, thank you. And just one follow up question just about the gross profit per unit levels. I feel like you've kind of already answered this, but just want to ask it maybe in a different way. Hypothetically, if ASPs fall another 5% to 10% over the next couple of quarters either given market conditions or just changing of mix? Are you guys still confident that the $2200 GPU level is achievable? And even in that scenario, so I just wanted to ask that more directly. Yes. Look, I think we feel very comfortable where we're running the retail GPUs. We'll continue to monitor the test. But look, I expect ASPs to continue to fall, which I think overall for the industry is a good thing to help drop some gap between new and late model use. So we feel comfortable with where our GPUs are and will continue to test. I want to follow up on John's question on expenses. Enrique, can you just provide some more color around really what the biggest inflationary drivers are in that other overhead costs fine? I think you pulled back, you said on some of the labor end of the season, and it's still up, $40 million year-over-year. So is any of that one-time increase? And then just taking a step back on expenses, I think even last quarter, we talked about, one of the reasons that you don't want to reduce headcount too quickly, is the need to hire back. And that gets harder next year. But now it sounds like we're expecting a softer backdrop for the next 12 plus months. So I guess why not reduce expenses or headcount more quickly across other parts of the enterprise? Thanks. Yes. And what I'd say there is that, we did, and so as sales got more challenged in the third quarter, we went deeper into the staffing levels in the field. And so, it's still through attrition. So it does take a little bit longer. But at the same time, we did lower our staffing targets to reflect the current sales environments, I tell you, we did go deeper into managing those expenses. And in regards to your first question, I think you're asking about the other expense line, and what goes in there, because it was a 41% increase, if you just look at the release, right? That is primarily because we're comping over the $23 million settlement that we had last year, if you back that out, you're looking at less than half of that as an increase. And what that really is attributed to is our investments in technology and product, right. And that's what that's attributed to. What I will tell you, though, as well, if you compare it to prior quarters, there is a reduction in the pace of that investment from a year-over-year standpoint. And so we've been pulling back there as well. You also see that manifested in our CapEx guidance for this year. We've taken that down from 500 to 450, the largest chunk of that decrease, really comes from a slowing down some of those projects, in addition to just slowing down some of the capacity initiatives that we have out there in terms of growing our capacity with lower volume, we're just slowing down some of those investments. And Daniel the only thing I would add there is, look, our culture is one that's a people first mindset, our people are the reason for our success. And that's the reason we chosen to allow attrition to get us to where we need to be. We will obviously continue to monitor the situation, but we're very comfortable with allowing attrition to get us to where we need to be. I just wanted to focus, sort of on the supply side here just for a second. I mean, when you think about the one- to six-year-old car fleet that's going to continue to probably shrink for the next couple of years. Competition is more focused on the [indiscernible], as you mentioned in the dealer. So it seems like the available one- to six-year-old car fleet is -- it's why is going to continue to shrink. But certainly what's available to you and other folks in the secondary market. But you've kind of mentioned going lower in the agent price spectrum, to drive volume. And you've shown an ability to kind of manage that fairly well. So I'm just curious, how fast you can move on that to potentially drive volume back up here, lower price points, but higher grosses, and maybe better returns, just on the capital employed. Yes. Thanks for the question, John. It's interesting, because we're kind of living a very similar life to what we did after the '08, '09 recession, you remember where you come out of that you have less newer cars, and it kind of has to work its way through. I tell you, we're in a better position today than we were back there just because our self-sufficiency is so high. And we'll be able to sell what consumers are looking for. And we're going to be able to get that really, in a better way than we could after 08, 09 because our self-sufficiency is so high. In my opening comments, one of the reasons our buyers were down so far, obviously, depreciation was the biggest lever, but there's also we made some decision just to slow down buys. And so there were retail cars that we purposely did not buy because of the risk of those cars in a highly depreciating type of market. So, again, I'm very comfortable with where we are and I think we're better positioned than we were in 08, 09. And I think we did a phenomenal job in 08 and 09 navigating that period. But maybe a follow-up, Bill, I mean, how fast can you move on this to drive comps positive? I mean, we understand that kind of the headwinds in sort of what was traditionally your core. I mean, it is obvious, you know it. I mean, you're going after it. I mean, when do you kind of just push and just increase, maybe materially the penetration of these older vehicles to drive the volumes higher? Because, I mean, the one thing that, it's very admirable is that the variable, GPU or the focus on GPUs, which is a variable cost analysis, but you do have these fixed costs that are high, particularly as Enrique was talking about these technicians. So you got to cover these costs at some point not, I mean when can you do this? I mean, something you are stating to do and but you're not doing it? Well, when you talk about penetration of older vehicles, but the penetration and how much we put out there is driven by the consumer demand, and not everybody wants an older, higher mileage type of vehicle that's less expensive. So again, that's all driven by demand. And as we see consumers continue to demand that will continue to put that out. But again, not everybody's -- not everyone's looking for that. Okay. So I mean, it's really a supply, I mean, it's getting to the supply of the core product more than being able to push older. Well, I think it's just more -- it's a bigger issue. It's just -- you have to go back to a vehicle affordability. It's just keeping a lot of people on the sidelines right now. And it's not only vehicle affordability, that's the lion's share. But you also have rising interest rates. If I look at CAF payments, just Tier-1 payment, just as an example. So the monthly payment, which is the biggest factor on whether someone's going to decide to buy a car or not, it's up 150 bucks year-over-year with the majority of that being driven by the vehicle price, with a smaller piece being driven by the interest rates. And I think you've got that which is obviously keeping people on the sidelines, not to mention just the overall inflationary pressures. And I think what we're trying to do is make sure that we've got the right amount of inventory, the right mix of inventory out there to meet the consumer demand and be very thoughtful about, our margins in order to cover the costs in the way that we're taking people first mindset on how we approach the business. Just to clarify for this sales environment where comps continuing to trend down 20%, you still expect SG&A to be flat to up year-over-year in the fourth quarter and going forward? No, I mentioned that you need to back out the $23 million we got last year in the third quarter. And so we would expect to be down year-over-year in the fourth quarter. It gets a little bit tricky Seth is like quarter-to-quarter things can happen. But our expectation is that we would be down year-over-year in the fourth quarter. Okay. And again, how much down and when you think about the 20% decline persisting when you decide to get more aggressive on SG&A? Yes. Well, we're not going to provide guidance on how much down in the fourth quarter because again, there's some variability quarter-to-quarter, but what I tell you is our expectation is that it will be down year-over-year. And if you look at the kind of the trend that we've been managing to -- I think we've been focused on SG&A. And we've been pulling the right levers so far. Now, if business doesn't pick up and deteriorates, we have other levers we can pull, right. But for the time being, we believe we pulled the right levers, and we'll continue to manage the business prudently as we always do. Got it. And my follow up question is just on the wholesale business, the wholesale to retail ratio in terms of units sold, declined sharply to 66% this quarter, would you consider this the new normal? No, I consider this what you would see in a highly depreciating market. When prices are going down a lot like they have been. And consumers have been told for the last year that this is the best time to sell their car, they can get more than they could ever gotten before. There's a disconnect there. And so as prices come down, it always drives our buy rate down. The other thing I would just add to that is that we stepped back, our appraisal advertising just given the volatility of the market. So no, I don't consider this the new norm. Following up on the SG&A question. I guess is there a way to contextualize how much you've taken out year-to-date of SG&A. And what that run rate is now in the fourth quarter because I'm assuming that those initiatives continued in the third quarter and into the fourth quarter. Yes. I think the better way to think about it Sharon, or the best way to think about it is just the cadence, the year-over-year cadence that we've had, because there's always seasonality that occurs right quarter-to-quarter in our business, and that also impacts SG&A. But if you again, if you go back to the first half of the year, Q1, we grew SG&A 19% up year-over-year in the first quarter. In the second quarter, it was up 16% year-over-year. This quarter, if you back out the legal settlement that we got last year, we're down 1%. So that's a significant decrease in the pace of SG&A. And so we are focused on it, we are managing to the current environment. And we think we're doing so appropriately. Now, if the business continues to be challenged, there's other things we can do. But for the time being, we've taken some pretty material steps to manage our SG&A. Yes. I think part of the confusion is, it sounds as if you're expecting SG&A to be down. Similarly, like down 1% in the fiscal fourth quarter year-over-year, but it also sounds as if you're continuing to proactively manage SG&A. And I think a lot of us are trying to reconcile that in our heads as to why we wouldn't see SG&A down a bit more year-over-year than what you saw in the third quarter, if that makes sense. We expect to continue to see SG&A kind of to go down. I think coming into individual quarter, it gets a little bit challenging to give you a number that we're managing too, many things can happen on a quarter. But what I tell you is thematically and practically we expect to continue to manage our SG&A down from a year-over-year basis. Okay. Maybe separately? I mean, how should we think about SG&A on a full year basis for next year? So you've got a lot of moving parts, you kind of have to keep your muscle intact for a potential rebound. But at the same time, you're dealing with a very difficult macro climate. So as we think about next year, particularly with the curtailment in the opening, I mean how are you viewing SG&A dollar growth? Yes. The way we're looking at SG&A is, we've given guidance in the past, like, hey, we need 5% to 8% gross profit go to lever, I think in this kind of environment, right? In this kind of macro backdrop, that kind of guidance is less important than what I'm about to say. So we are actually managing, and our goal is to get to kind of the mid 7%, 8% SG&A to gross profit, right, that is our first step on the way to improving our SG&A. Now we're going to need gross profit growth there, right. But that is our first step. Over time, we have talked about having an operating model that's more efficient than what it used to be. And we still expect that that's going to be over time, though, how many transformations and you can take a look at other retailers that have gone through it, it takes time to get to a better and more efficient operating model. But we expect to get back to where we used to be, it's just going to take time. Our first step is to get to kind of the mid 7%, 8% SG&A to gross profit, right. But again, we're going to need gross profit support to get there. In the meantime, we're going to continue to manage our SG&A appropriately for the market. And that's what we do. And you can see that's exactly what we did in the third quarter. We expect to carry that forward into the fourth quarter and into next year. And I think Sharon, we will also have a lot more visibility after the fourth quarter to really be able to tell you more depending on how the business does between now and then. And I'll try to hit the SG&A topic in a different way. But there's been a change in the competitive landscape. And I think it's been to your favor. And I'm wondering if philosophically, you could make a change in how aggressive you are with respect to SG&A given that, winning in this market may not be a sprint anymore, but might truly be a marathon and allow you to throttle back more aggressively than -- just low single digit percentage cuts. Yes, Craig. I think it about a little bit differently. I think similar to you, but we have competitors that are, obviously struggling. I don't think now is the time where, given our financial strength where we should be pulling back a whole bunch on SG&A. We have pulled considerably back. But at the same time, as I talked in my opening remarks, we also want to make sure that we're continuing to build for the future. And I think what everybody needs to remember is, we don't operate this business on a quarter-to-quarter basis, we operate the business for the success over the long-term. And there are some things that we're spending on that will absolutely help us longer term. Does it give us a headwind for EPS right now? Absolutely. But is it the right decision for the company long-term? Absolutely. So again, I think, really, my thoughts are on your questions, we're going to continue to walk this fine line. We want to continue to build out the muscle. We want to continue to find near term efficiencies, which we will do. And we'll continue to manage the business with a long-term view versus just a quarter-to-quarter view. And maybe just to follow up, I mean, obviously, the stocks under significant pressure, and it feels like you have the long term philosophy, but not enough shareholders are on board with it, is there something you can do to improve the messaging, or the guidance provided to maybe reduce the amount of surprise with which your results are met? I think the surprise is coming from macro factors to Enrique's point that we really, those are things that you can't control. And so what you need to focus on is what you can control and obviously, I think our long-term messaging is still more intact than ever. Yes, we've got some pain here in the short-term. But guess what we've seen pain before in the short-term. We've seen, if you look at market share, for example, which is a proxy for how I think success is going, if you look at market share, we've historically we've gained market shares. I mean, even in the time we are at 08, 09, we lost a little market share in the near-term, but then we quickly got it back. And then some more. Even if you look in the last few years, when you look back at like FY 20, when we started really rolling out our online capabilities, we saw a step up in market share gains. Unfortunately, we went into COVID, we gave a little bit back, but the following year, we got that back plus more. Now we're in a recessionary period. So again, I think everybody just needs to kind of keep a perspective of what we're going after long term. And yes, the short-term can be a little noisy, but the long-term message is still intact. Just wanted to ask a little bit more on the credit side for John, if you could give us some incremental color you had mentioned 2 to 2.5 is kind of normal for Tier-1. So what were the equivalent kind of loss ratio expectations be for Tier-2 and Tier-3? And then by way of follow up would be, can you give some incremental color around delinquency trends and roll rates, if possible, at all, by tier would be very helpful? Sure. Yes. Right on. Thanks for the question. The 2% to 2.5% is, again, our targeted range. I think we've done a great job staying within there. We've been in the Tier-3 business for since 2014, I think we've historically quoted, it's basically, you know, 1% of our receivables initially, it's now 2%. And obviously, substantially higher loss rates, I think we've put it's often 10% of our losses when it was 1%. So you're seeing maybe a 10x, 10-fold loss rate difference there in the Tier-3. Tier-2 is somewhere in between depends on where we choose to play there, there's obviously a wide spectrum. So hopefully, that gives us some color on how to expect losses, provisioning, whatever, around the different buckets, overall macro factors and delinquencies and losses, impacting our portfolio. I think it’s very clear delinquencies are on the rise in the industry, there's no doubt, you can see that within our ABS deals, we've mentioned that historically, there's certainly think pressure in the consumer. I think we've done a really, really strong job at working with that consumer. And while they might go 30, 35 days past due, helping them find solutions, such that it doesn't go into a charge off status. So we continue to fight that good fight and work with our consumers. As Bill mentioned, obviously, monthly payments are up, I think we've done a nice job of being responsible in our lending to our consumers and helping them through it. And ultimately, we reserve accordingly expecting all of this. So I think we're in a good position from a reserve standpoint, we'll watch the credit environment and the consumer very carefully. And hopefully that answers your questions. And maybe can you just contrast a little bit the current delinquency experience, you're seeing vis-à-vis, what was happening in 07 and 08? Sure. Yes, I think what you're seeing historically is, I would say, 07 and 08, you absolutely saw an impact across the entire credit spectrum substantially. I think what we've identified is, we're seeing a little more pressure on maybe the lower credit consumer, the Tier-3 into the Tier-2, maybe even a lower side of our Tier-1 space. So I see that definitely different. And again, I think that we're seeing delinquency pressure that that hint of a challenge for the consumer, but it really is not manifesting itself into loss. Again, we're going to watch it carefully. And we'll see what happens. But you absolutely saw more of an impact across the credit spectrum and into the loss side in 08, 09. And again, I think that's a very different environment. We can all agree with that, the labor pressure is back then versus now income for the worker. So we'll see where it translates. But I think those are the fundamental differences we've seen. I want to talk about your path to your target SG&A gross. It sounds like it's gross profit dependent on some level, but some of the gross profit levels like service and use volumes that are out of your control. I think it's probably fair to say the wholesalers took a pretty big step down this quarter. But you've driven significant improvement there. So I guess my point is like, where do you see the gross profit coming from? Is there any reason I think that wholesale could read on evidently. I think to Enrique's point earlier, it is a two-piece equation. We're controlling the expense side, the gross profit, we're going to need the business to come back. We're going to need it to come back. So, I think wholesale gross profit. Obviously, we made some good improvements there retail. Actually, wholesale and retail GPUs I think are both strong. Now it's about getting some of the volume back. I think, wholesale, I'm hopeful we can grow that a little bit more. Like I said, we did some things this quarter that probably slowed that down a little bit. But I think that's where it's going to be. It'd be dependent that's going to -- that'll carry some weight. Got you. Okay, Then, question on CAF quickly, the penetration jumped a ton, despite like a pretty large rate hike. And imagine like you've been more in terms of quicker to raise rates. And Bring Your Own Financing jumped a bit, too, as well. And Tier-2 and Tier-3 declined. You're also adding new partners onto the Tier-2, Tier-3 network, if I heard that correctly. So you can talk about you're seeing there an aggregate or the Tier-2 and Tier-3 tightening credit at the margin. Does your new instant appraisal tool that you've added? It sounds like it includes the partners more. Will that help drive penetration of Tier-2, 3. Just any thoughts there would be helpful? Yes. Let me take them sequentially here. So just remark one overall penetration, yes, we mentioned in the prepared remarks, CAF penetration is up -- in tandem with actually us raising rates, I think that's something we're really pleased about. We know that generally, you're going to lag the market. Again, we're competing with credit unions at the higher end. But I think we've done a fantastic job at raising rates 40 basis points sequentially, 150 basis points year-over-year, and still captured that penetration. So we're pleased with that. You see, the Tier-2 penetration down from last year. And that's your three penetration down. I think that's a combination of two things. You absolutely see the consumer challenge there, as Bill mentioned. You still see an affordability issue there. But yes, absolutely. As we mentioned, lenders are being very -- what they need to do to operate independently and pull back where they need to. And I think there's the benefit of our platform, you've got a number of lenders, they're going to work together to figure out what's best for them, but collectively provides a good credit offer in the long run. So I think that's you definitely see pullback there. Chris, last part of your question, I think you mentioned -- not instant appraisal tool, but our pre-quarter tool. Just to clarify there. We mentioned that we're continuing to add lenders on to that tool. Again, we think it's a best-in-class tool, it requires a lot of nimbleness from our lenders, they're all coming on board. Are we seeing engagement there? Yes. I don't know that that's necessarily driving a ton into the penetration story, albeit that tool does bring a better credit quality consumer to the application process. But so does that answer your questions? What else have I missed? Nothing. You got my laundry list. And thanks for correcting my misspoken. Yes, that's why that was the insert. Sorry, I said began the financing penetration tool. Thank you. I just wanted to kind of get some color around. You talked about competitors acting aggressively to preference units versus price where you guys’ kind of do the opposite. Is that positive because it means the industry is moving back to normal, but or is it a short-term negative because they're going to have fresher inventory that's going to lower your unit numbers and just kind of want to know how to think about that and how that's kind of trended in the past. You've talked about seeing this before? Yes, Chris. I think what you're saying is, there's competitors out there that just aren't -- weren't moving any inventory and depreciation has been very steep. And so what they're doing is they're trying to move some of that inventory. We've seen this in the past, in a lot of cases, it's not sustainable over the long-term, because you're just not making the money that you need to, but you're trying to get units moved. It's again, the reason why we did the expensive price. That's we wanted to see what the elasticity. And we did prices both up and down. So we did prices down, we also did price tests up just to kind of better understand it, which again, just gives us confidence that we made the right decision from a profitability standpoint. It looks like you had a really great free cash flow generation quarter from an inventory reduction. And I'm just curious, I guess, wanting you, how much longer can you reduce your inventory to get that free cash flow benefit yet still have adequate vehicle inventory to sell? And then, you paid off the revolver with some of that free cash flow? Do you also want to pay off that June 24 term loan to get some more balance sheet health, would you rather have that cash on hand? Yes. I think in this kind of environment, I think having some cash on hand isn't a bad thing. And we absolutely used the really effective management of inventory like Bill talked about. We decreased overall inventory year-over-year, but we actually increased our sellable inventory. So that's some impressive work by the teams to work through our WIP. And so that was really good news. We used that cash basically to, as you mentioned, to pay down the revolver, this quarter take it down to zero, that would be of no tap on our revolver. And at the same time, sit on some cash, I just think, David in this kind of environment, it's not a bad thing to have some cash as well. So it gives us ultimately the flexibility to manage through this kind of environment. And, we have a really strong balance sheet. We're proud of it. And we have flexibility that others don't have in the industry. And I think that puts us in a position of strength. And somewhat related, the buyback pause. I do understand wanting to be prudent. But should we interpret this to mean you guys are less optimistic about maybe the short to mid-term than you were three months ago? Well, it's important that we run a conservative balance sheet in this kind of environment. And as I mentioned, in my prepared remarks, we do look at our net leverage ratios in terms of something to manage to carefully to make sure we have ultimate flexibility when it comes to having funds and managing CAF. We do have a very large cap to finance organization. And that's just a key consideration that goes into it. So I think until the business kind of improves, and just as importantly, the macro backdrop improves, I expect that we will pause the share buyback. That being said, we remain fully committed to the share repurchase program, and we'll get back into it at the appropriate time when things improve, and the outlook improves. Yes, David, that's about our views have changed on, things are going to get worse. It's just more about the uncertainty. Thank you. We don't have any further questions at this time. I'll hand the call back over to Bill for any closing remarks. Thank you, Ashley. Well, listen, thanks, everyone for joining the call today and for your questions. As I said multiple times today, we believe we're well positioned to navigate this environment and I do think, we will emerge an even stronger company. I want to thank again, our associates for everything they're doing in their commitment to each other and the customer and the communities and the environment. And I want to wish you all a happy holiday season and we look forward to talking again next quarter. Thank you. Thank you. Ladies and gentlemen, that concludes third quarter fiscal year 2023 CarMax earnings release conference call. You may now disconnect.
EarningCall_1456
Greetings, and welcome to the QCR Holdings, Inc. Earnings Conference Call for the Fourth Quarter of Full-Year 2022. Yesterday, after market close, the company disbursed its fourth quarter earnings press release. If there is anyone on the call who has not received a copy, you may access it on the company's website, www.qcrh.com. With us today from management are Larry Helling, CEO; and Todd Gipple, President, COO, and CFO. Management will provide a brief summary of the financial results, and then we'll open up the call to questions from analysts. Before we begin, I would like to remind everyone that some of the information we’ll be providing today falls under the guidelines of forward-looking statements as defined by the Securities and Exchange Commission. As part of these guidelines, any statements made during this call concerning the company's hopes, beliefs, expectations, and predictions of the future are forward-looking statements, and actual results could differ materially from those projected. Additional information on these factors is included in the company's SEC filings, which are available on the company's website. 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 the financial and other quantitative information to be discussed today, as well as the reconciliation of the GAAP to non-GAAP measures. As a reminder, this conference is being recorded and will be available for replay through February 1, 2023, starting this afternoon approximately one hour after the completion of this call. It will also be accessible on the company's website. Thank you, operator. Welcome everyone and thank you for taking the time to join us today. I will start the call with a high-level overview of our 2022 performance, a review of our business model, and the factors that drive our success. Todd will follow with additional details on our financial results for the fourth quarter. Our record net income in 2022 was driven by robust loan growth and increased net interest margin and excellent credit quality. Our team accomplished this while successfully closing and integrating our largest acquisition to date where we significantly strengthened our company's position in the vibrant Southwest Missouri region. Our growth in earnings over the last five years has been exceptional. This is a result of our differentiated business model and commitment to relationship banking. Our multi-charter model provides our bankers with the agility to serve our clients. We delivered banking at the local level, which creates opportunities to strengthen current relationships and establish new relationships that drive our growth. In the last five years, we have nearly doubled our size, outperforming many of our peers. Our total loans have grown at a compounded annual rate of 15.7% and our deposits at 12.9%. These results support the 20.7% compounded annual growth in our core diluted earnings per share and the 10.2% compounded annual growth rate and our tangible book value per share over the same period. Importantly, while we've been able to grow at a consistent pace, we've also significantly increased our profitability and our ROAA is now in the top quartile of our peer group. There are many factors that contribute to our success, including our dedicated employees, our economically vibrant markets, and our differentiated business model. Recruiting and retaining the right employees is critical to our success. We have strong corporate cultures that extend through each of our local charters. Our employees are engaged with our clients and involved in our communities. Our reputation and culture attract the best bankers and clients in our market. This leads to important outcomes such as reduced turnover, improved productivity, higher profitability, and enhanced shareholder value. We continue to receive high employee engagement scores, which are measured annually across our company. Our local charters have won numerous awards throughout our footprint for being a great place to work and do business. This has resulted in consistent and sustained growth. We operate in some of the most vibrant midsized markets in the Midwest. They are part of regional economies with a diverse mix of commercial, industrial, and technology-focused activity along with highly educated workforces, which helps drive steady economic growth, high relative household income, and low unemployment. Our unique model enables our local management teams to operate with the speed and agility to respond to client needs, which results in a better client experience that outperforms larger national and regional banking alternatives. This has created great outcomes for our employees, our clients, our communities, and our shareholders. Our management teams think and act like owners, which drives shareholder value. In addition, we have built high performing business lines that provide additional opportunities for growth and profitability. Our Specialty Finance Group provides municipal and tax credit specialty lending, which drives strong growth in bonds and loans, as well as fee income. On the deposit side, our correspondent banking team serves the banking needs of nearly 200 downstream correspondent banks, which generates meaningful core deposits and related fee income. Lastly, we've grown our wealth management significantly over the years with assets under management of $4.6 billion. The combination of our traditional banking and our high performance business lines creates a diverse revenue stream, which has helped us outperform in a variety of economic environments. We support our local charters with centralized group operations teams providing the required operational infrastructure, expertise, and benefits of scale. We aim to be a market leader in each of our markets as this scale improves our efficiency and enables us to attract the best bankers and clients. Relationships build on expertise and trust matter in our markets and that is why we place such importance on high touch client service that is delivered at the local level. Now, a few comments on our full-year 2022 results. We delivered net income of $99.1 million for the year or $5.87 per diluted share. After adjusting for the one-time costs associated with the Guaranty Bank acquisition, our adjusted net income for the year was $114.9 million and our adjusted EPS was $6.80 per diluted share, up 14.8% and 8.5% respectively over our 2021 results. Our team accomplished this, while successfully closing and integrating our largest acquisition to date as mentioned earlier. Organic loan and lease growth for the full-year was 14.6% when excluding PPP and acquired loans and was driven by strength in our traditional commercial lending, leasing, and specialty finance businesses. Given our current pipelines and relative strength of our markets, we are targeting loan growth of between 8% and 10% for 2023, consistent with our long-term goals, while continuing to be vigilant on maintaining our exceptional credit quality. While our deposits for the year were relatively static when excluding deposits acquired in the Guaranty acquisition, the number of net new accounts continue to grow, which will lead to consistent deposit growth over time. Core deposits are our long-term focus, which will drive long-term franchise value. [Accordingly our] [ph] bankers are [indiscernible] to grow both loans and deposits. During the year, we expanded our tax equivalent yield net interest margin by 24 basis points, driven primarily by our asset sensitive balance sheet in this rising interest rate environment. Our asset quality remains as the ratio of non-performing assets to total assets was 11 basis points at the end of the year. We had modest net charge-offs during the year and are comfortable with our reserves, which represent 1.43% of total loans and leases. We are mindful of recessionary concerns, but remain cautiously optimistic about the relative economic resiliency of our markets. Additionally, our strong asset quality and consistent credit culture prepares us well to weather economic uncertainty. In conclusion, I would like to thank the entire QCR Holdings team for their engagement and dedication to outstanding client service and for delivering record adjusted earnings for the year. Our employees are the key to our success and I'm immensely proud of all that we have accomplished in 2022. With that, I will now turn the call over to Todd, to discuss our strategy to drive shareholder value and our strong financial results. Thank you, Larry. Good morning, everyone. Thanks for joining us today. When Larry and I began our new roles with the company in early 2019, we developed an initiative to drive our financial results and enhance shareholder value. We call this our 9, 6, 5 strategy, a plan to grow earnings and drive attractive long-term results for shareholders. This strategy includes at a minimum generating organic loan and lease growth of 9% per year funded by core deposits, growing fee-based income by at least 6% per year, and limiting annual operating expense increases to 5% per year. These are long-term targets and not short-term quarterly benchmarks. Our 9, 6, 5 strategy creates a common language across the company that unites our teams and aligns our actions for long-term success. We believe that the true measure of our success will be our ability to consistently deliver on our strategic initiatives over time and this will translate into greater shareholder value in the long run. As a result of our performance on our strategic 9, 6, 5 initiatives, combined with our successful acquisition of Guaranty Bank this year, since 2018 we have grown adjusted net income and EPS at a compounded annual growth rate of 25.4% and 21.9% respectively. And we are proud to have achieved top quartile ROAA and NIM within our high performing peer group. While our historical performance has been impressive, we remain focused on the future and expect to continue to perform at the top of our peer group over the long-term. Now, I would like to provide some color regarding our fourth quarter results, starting with net interest income. Our net interest income on a tax equivalent basis was 70.8 million, an increase of 5.5 million from the third quarter. The increase was primarily due to higher acquisition related net accretion of 4.6 million due to loan renewals, restructurings, and pay-offs from our Guaranty Bank acquisition. And the impact of multiple interest rate hikes on our asset sensitive balance sheet, partially offset by the impact of increased deposit costs. With our strong growth in earning assets and improved loan yields, we significantly grew interest income for the current quarter. However, we also experienced higher interest expense as a result of higher deposit costs, a shift in the mix of our deposits, and the full quarter impact of our recent subordinated debt issuance. Our NIM on a tax equivalent yield basis improved by 22 basis points during the fourth quarter, driven by the higher loan yields and higher acquisition-related net accretion and partially offset by higher deposit costs. As we have mentioned before, NIM is impacted typically in nonlinear patterns during periods of rapid rate increases. In the first half of 2022, we experienced the benefits of slower and lower deposit betas as we posted a NIM, TEY increase of 24 basis points during that period. However, those deposit betas accelerated as we progress through the second half of the year before additional Fed rate increases. For the first half of the year, our beta on total deposits was 8%. For the third quarter, our beta on total deposits moved to 31%. And for the fourth quarter, it was 44% as a result of an accelerated shift in our deposit mix for noninterest-bearing to interest-bearing accounts and from demand deposits to CDs. For the full current rate height cycle to date, our beta on total deposits is 27%, which is comparable to our beta from the last period of rising rates that ended in 2019. With robust organic loan growth and NIM expansion for the year, our net interest income has also experienced significant growth, and we have achieved a NIM at or near the top of our peer group. Looking ahead, we project our NIM, excluding the impact of acquisition-related net accretion, to remain fairly static in the first quarter of 2023. Additionally, we expect acquisition-related net accretion to return to a more normalized level of approximately 500,000 per quarter. Turning to our noninterest income, which was 21.2 million for the quarter, up slightly from the 21.1 million we generated in the third quarter. Notably, our capital markets revenue was 11.3 million, an increase of 800,000 from the third quarter and within our guidance range of 10 million to 12 million. Despite the project delays that some of our clients have been experiencing, our pipeline remains strong. Capital markets revenue has averaged just over 10 million per quarter for the last four quarters, and therefore, we expect this source of fee income to be in a range of 40 million to 48 million for the full-year 2023. In addition, we generated 3.6 million of wealth management revenue in the fourth quarter, up slightly from the third quarter. Our wealth management team continues to generate meaningful new client relationships and is adding significant new assets under management, adding 340 new clients and 481 million in AUM this past year. This strong growth in new clients helped offset the sharp decline in stock market valuations that occurred in 2022. Now, turning to our expenses. Noninterest expense for the fourth quarter totaled 49.7 million, compared to 47.7 million for the third quarter. The increase from the prior quarter was primarily due to higher incentive-based compensation related to our record full-year performance, partially offset by lower professional and data processing fees due to the completion of the core conversion at Guaranty Bank and other merger cost savings. Looking ahead to the first quarter of 2023, we anticipate that our level of noninterest expense will be in the range of 49 million to 51 million. This guidance range reflects less than a 5% increase in our fourth quarter noninterest expense run rate after excluding acquisition-related items and is consistent with our strategic 9, 6, 5 initiatives. Turning to asset quality, which improved significantly in the fourth quarter and continues to be quite strong. Nonperforming assets declined by 51% to 8.9 million at the end of the fourth quarter driven by payoffs of several NPAs during the quarter. The ratio of NPAs to total assets was [0.11%] [ph] at quarter-end, compared to 0.23% for the prior quarter. In addition, the company's criticized loans and classified loans to total loans and leases at the end of the fourth quarter were fairly static at 2.68% and 1.08%, respectively, as compared to 2.35% and 1.29% from the prior quarter. As a result of continued improvements in overall credit quality, the company recorded no provision for credit losses in the fourth quarter. Our allowance for credit losses remained strong at 1.43% of total loans and leases. This allowance represents 10x our nonperforming loans and leases. We strengthened our total risk-based capital ratio during the quarter, posting an improvement of 9 basis points to 14.47%. We also increased our tangible common equity to tangible assets ratio to 7.93% at quarter-end, up from 7.68% at the end of September. Our tangible book value per share increased by 6.8% during the fourth quarter. This was due to both our strong earnings and a $10 million increase in AOCI as a result of an increase in the value of our available-for-sale securities portfolio and certain derivatives due to changes in long-term interest rates during the quarter. During the fourth quarter, we purchased and retired 100,000 shares of our common stock at an average price of $50.37 per share, as we executed purchases under the share repurchase plan announced during the second quarter of 2022. Finally, our effective tax rate for the quarter increased to 15.9% and from 14.1% in the third quarter. The rate was higher due to a higher ratio of taxable earnings to tax-exempt revenue in the fourth quarter. Our effective tax rate for the full-year 2022 was 12.8%, an improvement from 18.6% in 2021. This was primarily due to strong growth in tax-exempt revenue, mostly from tax exempt floating rate loans, as well as increased benefit from our tax credit portfolio. We expect the effective tax rate to be in the range of 12% to 14% for the full-year 2023. On the nonperformers, kind of the cleanup there, could we get any more color on the payoffs were those credits that you've been working on for some time or just, sort of what type of loans were those looking for any, kind of color? Yes. The only one, Jeff, that was over 7 figures, was one commercial real estate loan that we had fully reserved for several quarters. And we just thought there's a dispute between, not us, between the borrower and a contractor, and we decided that it would be best just to charge it off. And so, we would hope to get some recovery in 2023, but because of the dispute, we decided it’s best just to clean it up. The other couple of credits, there were a couple that were 6 figures that we decided just to clean up, and so you saw some really nice improvement in our NPAs. We had one large NPA that just paid-off that was middle 7 figures. It's been on our list for a long time that we got paid off in the fourth quarter. So, over the last two quarters, we've dropped our NPAs by two-thirds down to what a number I didn't think was possible a few years ago down to 11 basis points. So, our team has done a great job there. No substantial recoveries. We expect a couple of those in 2023 because of the cleanups here, but just small odds [indiscernible] stuff, nothing substantial, Jeff. Okay. Todd, just to kind of narrow in on the margin, do you have the average in the month of December, what that [was] [ph]? Sure. Jeff, great question. That's one of the reasons we were guiding to a static margin intra-quarter, we actually saw improvement each month in margin. Our core margin was [3.61] [ph] for the full quarter. It was [3.59] [ph] in October, [3.60] [ph] in November and [3.62] [ph] in December. So, we got some nice run there intra-quarter. Part of that was – for the first time, we were really seeing the improvement in new loan yields that we had expected candidly to start in the fourth quarter. It was really more towards the end. Our yields on new loan fundings in December were 80 basis points higher than October. So, part of the run up there towards the end of the quarter. Okay. And I know that you, kind of gave us a little read on Q1, but thereafter, it's – any expectation would be near at, kind of that level as maybe deposits, kind of chew into earning asset yield improvement or kind of what would be the further around expectation? Sure, Jeff. I think static is going to continue to be the right word for us, whether it's Q1 or looking a little further into the year. We feel really good about not only the intra-quarter improvement and that traction on fixed rate loan pricing, but part of the challenge we have with margin in the fourth quarter is, we saw a very significant, more than we had forecasted, shift from noninterest-bearing and low beta deposits into higher beta and CDs. We saw a pretty significant runoff in correspondent balances, 55 million in noninterest-bearing, 66 million in money market, but that has reversed already here in January, which gave us significant confidence in talking about a static margin. So, correspondent deposits have started to come back quickly in January. Noninterest-bearing is up 33 million, money market up 221 million, and we feel really good about the start to the quarter. So, kind of long answer to your short question, Jeff, I think static is really the word not just for Q1, but as we look a little deeper into 2023. Okay. And just to confirm, we're talking about core and I'll take into account your comment about the expectation for accretion to return more to normal levels. Yes, Jeff. Exactly. We wanted to be pretty prescriptive about that given the big jump in the fourth quarter. Actually very pleased by that. The level of restructurings and payoffs in that portfolio with good outcomes. It did accelerate the accretion, but now we'd be back to more like a [500,000] [ph] run rate. So yes, when you're doing your modeling pull out the [$5.7 million] [ph] in the fourth quarter, replace it with [500,000] [ph] thereafter. Jeff, I'd add just a comment. I'm thrilled to see that [discount accretion] [ph] accelerate because that means that the – some of those individual credit marks that we put on what we perceive were some of the higher credits, we were able to get rid of because they either paid off or restructured in a way that we thought was appropriate. So that speaks well and shows up early in our NPA numbers and the tremendous progress we've made in the last couple of quarters. So, just wanted to, kind of circle back on the credit front. It sounds like things are really strong there, but – can you give us a little guidance, Todd, on how we should think about the provision going through 2023? Reserve was pretty healthy at [143 ], do you feel you need to maintain that? Is there some room to let that go down a little bit? And just trying to get a little idea on the cadence of the provision over the coming quarters. I will take the [first one Todd] [ph] and then let Todd fill in the gaps here. We think we're very comfortable with our reserve today when our reserve coverage is 10x our NPAs, but it also seems like the right time to not let that number flow a lot lower. So, as we look through the rest of the year, we're certainly going to need to start providing a little bit of reserve for the growth that we've had. We've seen no degradation in credit that's apparent in the numbers as you see with our classified numbers coming down, our NPA numbers coming down in the quarter, but we all expect at some point for things to start to return to more normal, there's certainly nothing in the numbers that show that that's going to happen in the first quarter or two of next year – or this year, excuse me, depending on what happens to the economy, certainly, there's some of that possible later in the year, but it's not showing up yet. So, we would expect if we do have reserving, it's probably going to be a little more back-end loaded during the year because of credits holding up, but we'll have to reserve a little bit and hope to maintain at above the levels we're at for the next few quarters. Got it. Okay. That's helpful. And then with regards to expenses, Todd, could you just repeat what your guidance was as you look into the first quarter and as kind of as we progress for the remainder of the year? Sure. We're really looking for a range of 49 million to 51 million. Again, we're pleased with the outcome on our expense run rate that's staying under the 5% in our 9, 6, 5. So that would be our guidance, 49 million to 51 million, gives us a little bit room for some increased costs there, but we feel very good about run rate on noninterest expense. We have really accomplished a great deal of the cost saves from the Guaranty Bank acquisition and merger and integration. We did carry a little bit heavier staffing over year-end. We really wanted to make sure we were taking great care of clients and making sure we were doing all the right things from a control environment perspective. It's a marathon, not a sprint. So, we wanted to make sure we have things well in hand over year-end. We mentioned some of the incentive-based compensation in a little bit of the [indiscernible] in fourth quarter expenses. We also got more fully staffed. One of the things we didn't really talk about in our opening comments, but you might have noticed that our FTE headcount was up [17] [ph] linked quarter. So, we're doing a lot better job of getting fully staffed and things are going well from a people perspective. Okay. Great. And then just one quick final question. With respect to like the commercial real estate portfolio, how much office exposure do you guys have? And are you seeing any signs of weakness in that segment? Yes, I'll take a swing at that one, Damon. Our office exposure is about 3% of our portfolio, so we don't have big exposure there. And as I look at it, we only – we have 16 deals that are over $3 million in size. 13 of those are 100% leased, and the others really have pretty good sponsors. And the one – we had one struggling deal that we got paid off during the fourth quarter. So that portfolio is performing really well. We have very little what you would think about in big markets where we've got office towers, still with multi-tenants. We have very little of that. Our tenants are more likely government-related entities, accounting firms, medical office facilities, those kind of things. And so, ours are holding up really well so far. So, really no issues in that portfolio so far. Again, it's about 3% or 188 million of our total portfolio. Maybe we just start – I know you gave the outlook on the swap fee income. And it does feel like we've hit a pretty stable run rate for that line item. What would you expect to be, kind of the lever for that run rate to, kind of increase back to levels that you saw in prior years. It's – beyond 2023, I guess, is how I'm thinking about this. Yes. Our first focus is certainly trying to produce consistent results like we have in the last couple of quarters. What will help that longer-term as we've been talking about the headwinds for a couple of years now when we had tremendous inflation, which slowed down the project construction because of [getting materials] [ph] and the inflationary cost of the materials. That was one factor. The other was higher interest rates had some impact on the cash flow on projects because the debt service is higher with long rates, kind of topping out and coming back a little bit. So that has started to help. And so, I would say the factors here that it would really increase that over time would be a continued reduction in long-term interest rates, and kind of inflation getting under control so that the certainty of the cost of projects are easier to get to because they've got to put their capital stacks together, and getting back to a normal inflationary environment on building materials would certainly help. Yes. That makes sense. And do you have an outlook for the remainder of the fee income this year or in the first quarter, excluding the swaps? Yes. Danny, probably the biggest bucket of that would be wealth management. And you heard our comments in the open – with respect to new clients and new AUM. So, in keeping with 9, 6, 5, we would expect to see wealth management in other parts of our fee income business to grow at 6% annual. Okay. Terrific. And then just lastly, you talked a lot about the margin here and funding loan growth, but I think in the past, we've asked about the loan deposit ratio of it around 103% now. How comfortable are you or how high are you comfortable letting that ratio go? And then what's the strategy for funding loan growth if it is more difficult than expected to bring in core deposit growth? Sure. So Daniel, I was hoping someone would ask about loan-to-deposit ratio. Yes, it was over 100 right at quarter-end, year-end, it's floated back down into the 90s now with some of the return of that funding I mentioned with correspondent banking. So, we will run that in the upper 90s, we prefer to keep it under 100, but it's likely going to be in that 95 to 100 range. We do expect all of our bankers to find the funding we need to continue to grow loans at the guidance rate that we gave you. So, we don't expect that to float any higher. One point of color is, we've historically run at this rate on loan-to-deposits. We ended 2018 at 101 and 12/31/19 was 98%. So this isn't a new phenomenon for our company. We've always had a very strong loan growth engine keeping pace with that with funding has always been a key priority for us. But it's part of the reason that we perform at a high level with respect to margin and ROAA. The left side of our balance sheet is fairly heavily to loans. And so, we're pretty comfortable operating in that upper 90s. It's historically a normal range for us. So Danny, the other thing I would say is, we've talked about this for a few quarters now, and we are on track to do a securitization of a portion of our LIHTC portfolio in the second quarter. Our first tranche, just to get the first ones done is likely in the $150 million range. We're working on the details of that as we speak, but we do expect to do a securitization, which will take some of the pressure off the funding in the second quarter. And longer-term, that's a lever we'll be able to pull over time, create additional liquidity if we need to. One of mine was just answered or answered on the LIHTC and on the deposit. Other one, just on, Todd on the portfolio, just kind of the pipelines or Larry, just kind of the pipelines today that are – it sounds like they're pretty healthy if you're kind of thinking about your guidance along with maintaining the credit quality, but just where are the pipeline is today? Is it specifically in the, kind of the traditional commercial and the specialty finance or is that kind of what's driving it, or just geographically, just maybe give a little color on where the pipelines are at? Yes. I'll start, Brian, and let Todd fill in if he's got some other thoughts. Certainly, I would say, I looked at our pipeline trends this morning, again, they are very consistent over the last couple of quarters for new business and new transactions that we're working on. What's changed, as you know, we and others had really frothy growth earlier in the year in that 14%, 15% range really because of the liquidity coming out of the system and clients starting to use their lines of credit and those kind of things. Our line of credit usage for clients is back close to pre-pandemic levels now. So that big push on liquidity and loan increases is, kind of done, we could get a little bit more uses there, but it's pretty much – the excess liquidity seems to be, kind of pushed out. And so both the Specialty Finance Group and the core business pipelines look solid. So, we'd expect consistent growth from both of those and get us more back in what we've done over the long run, which is kind of numbers in that 8%, 9%, 10% range is what we've done over years. And so, it won't be easy. We'll have to work hard to achieve at those levels, but that's something we've done over a long period of time. Got you. Okay. No, that's helpful. Thanks Larry. And just the LIHTC portfolio today are just kind of the specialty finance pipeline, if you think about the securitization, how big is that portfolio today when you think about taking something off the table there with securitization? So yes, I mean, the stabilized LIHTC portfolio is around $750 million, which we believe to be probably the highest quality asset we have on our lending balance sheet. The first tranche, we could theoretically securitize all of that. That's not likely because we like it on our books, but we're going to pull the first $150 million off in the securitization as we discussed just to have that tool available because we've got consistent growth in that market. And so, if we want to take the top off the growth there and create a little extra additional liquidity, we want to make sure we've got that lever completely figured out, so that it's there when we need it in the future. Got you. Okay. So, that's the LIHTC piece, the whole piece of Specialty Finance loans, how big is that the portfolio today? There's another $700 million roughly in between municipal lending that we've done and some like that construction. So, it's a big piece of our business. But again, we think some of the very highest quality stuff that we have. Yes. No, understood. So, I just want to get a frame of how big it is. So, okay, that's helpful. And maybe just on the capital front, given kind of the build here and just the look on AOCI. Have you – how does your look on the buyback? I mean, I know there's still uncertainty out there with rates economically, but just trying to balance that or just understand how you guys are thinking about it. So, great question, Brian. First, I would say, we feel really good about where our capital levels are at today. Given the awareness in the AOCI environment and the economic uncertainty, our priority going forward is growing TCE and total risk-based capital. As you know, our operating performance is certainly top quartile in our peer group now, and we expect to keep that there. What we're driving to now longer term is to get our capital ratios, we're kind of middle of the peer group right now in our capital ratios. We'd like to push those to the top quartile because the shareholders, we think, will be well served in a possibly tougher economic environment. If we've got top quartile earnings and top quartile capital, we think we are well-positioned to weather the storm that might be in front of us, but [it hasn’t] [ph] shown up yet. Got you. So, maybe not quite as active on the buyback in the near term, just given, kind of your commentary. Is that fair? Yes. Got you. Okay. And then maybe just last one for Todd. Just on the margin Todd, I think normally, you'll give the RSAs, just kind of where those are at, but just in general, as you look to – it sounds like the funding base, just kind of your assumptions on the stability in the margin, it sounds like it's just maintained the deposit. You've talked about the kind of changes in mix and funding and whatnot. But your outlook for some stability, is that assuming that the deposit mix and the borrowings – level of borrowings today are consistent or down or just kind of how you're thinking about that? Sure, Brian. Yes, we feel pretty good about where we're sitting today, still being slightly asset-sensitive. And our guidance to static margin, yes, does assume that the big mix shift that we've seen lately has really come to a conclusion. We feel very good about that considering how we started the year here in January. We've been able to pay down borrowings pretty significantly as correspondent and other deposits have flown back in or flowed back in. So, we've been paying down overnight borrowings getting some margin benefit from that, feeling better about loan to deposits being in the 90s instead of over 100. So, all those things are – yes, that's what we're assuming in that guidance. Sure. So, RSAs are still 2.4 billion and still continue to see some nice lift there. I think that has been a very positive trend throughout the rate up cycle, of course. But probably the biggest thing that we saw late in the fourth quarter, as I mentioned earlier, was we're really finally starting to see that traction on new loan yields, on fixed rate deals, and that jumped 80 basis points from October to December. So that gives us some more confidence about being able to help us with margin. Just wanted to zoom-out on the margin outlook. We contemplate maybe a couple of Fed rate hikes in the back half of this year. Do you guys believe that just the higher pricing that you're seeing on new loan production today can offset just some of the variable rate loans repricing lower? Within that context, obviously, you’ll have some index deposits that will also reprice lower. So, I guess I'm just kind of curious how you guys are thinking about, kind of protecting margin if we do get some Fed cuts later this year? Sure. Nate, actually, as I think you know well, the right side of our balance sheet is a bit more of a challenge for us with the ratio of commercial deposits to retail deposits. And that's really been our struggle in terms of margin and holding on the margin. That does give us a very good outlook if the Fed was to cut rates later in the year. If they were to do that, I think we'd likely outperform many in terms of our ability to bring cost of funding down quite quickly. We would be able to take those rate-sensitive liabilities down pretty sharply. They have performed that bucket that we would call like our 100 beta bucket of deposits. So far, it's been 91% over the cycle. And so, we think it would perform well in rates down and give us some relief on cost of funds quite quickly. Okay. Great. And then just one clarifying question to Larry's point earlier, on just the reserve. Larry, were you describing a kind of a stable reserve on an absolute dollar basis or stable in terms of just as a percentage of loans? Yes, thanks for that clarification. Yes, probably stable as a percentage of loans. We're in a – we're still pretty high particularly given 11 basis points of NPAs, but that – we'd like to hold in that low 140s range for now, possibly build it if we see economic headwinds, but certainly hold it there so that we've got some powder in our reserve if we do see some degradation later in the year. Got you. And then just maybe lastly, just in terms of the M&A outlook, are you guys still kind of less interested in opportunities these days, just given the macro environment and interest rate fair value marks and so forth, how are you guys kind of thinking about and seeing kind of the flow of those opportunities develop these days. Yes. Nate, good question again. Certainly, it kind of goes in-line with stock buyback questions earlier in the call. Our focus is on building capital right now. And the M&A environment is given all the uncertainty going on, certainly less likely. So, long-term, certainly, we'd be open to things, but in the near term, certainly, we don't see anything and our focus is on build on a [indiscernible] balance sheet that will stand the test of time here if we do see economic uncertainty. This concludes our question-and-answer session. I would like to turn the conference back over to Larry Helling for any closing remarks. Thank you, operator. I'd like to thank all of you for joining us on our call today. We hope everyone remains healthy and safe during the new year. Have a great day. I look forward to speaking with you all again soon.
EarningCall_1457
Well, good morning. And for those joining us on the webcast, welcome back to Citi's 2023 Communications, Media & Entertainment Conference. For those of you I haven't met, I'm Mike Rollins, and I cover Communication Services & Infrastructure for Citi Research. Before we get started, I'd like to mention that we have disclosures available at the registration desk and on the Citi Velocity page from which you're streaming the audio. We also like to incorporate your questions in today's discussion. If you're here with us, we'll have a mic towards the end of the session. And if you're streaming this connection, there's a question box on your screen, and you could enter your questions that way. And we're going to continue the tradition of live audience surveys that are completely anonymous, and can be accessed on the Live Polling Q&A section of the streaming site, as well as through your connected devices here live, and the QR codes are around us, and please login and submit your requests that way. So, with all those details out of the way, I'd like to welcome Kate Johnson, President and CEO of Lumen. Kate, thank you so much for joining us today. Thanks for having me. It's great to be here. And, by the way, can I throw in a little in case we do anything that's talking about forward-looking statements? I'd like to remind everybody to go to our IR page and look at our Safe Harbor language there just to keep us in check. So, with that, can you share with us why you took the job at Lumen? And what have been the surprises, the positives, the challenges you've experienced since you've taken the helm? Sure. Well, I'll really start with, there haven't really been many surprises when you go through a selection process, like the one I went through with the Board, you learn a lot about the company throughout. And the people are great. The assets are great. We have a huge opportunity, but there's a challenging road ahead, we've got a lot of work to do. Why I took the job? All the reasons I just talk about, right? The people are great. The assets are great. And I kind of thrive in the challenging world driving digital transformation and leading people through change, that's what I've been doing for a couple decades. And I just love it, so I'm excited to be here. Great. Well, thank you for being here to share some of your initial perspectives on the go-forward plan for Lumen. We're going to get our first live survey out there for our audience, and we'll come back to it in a few minutes. But the question that we're asking our audience is, what is the best way Lumen can create value over a three-year horizon? And we came up with, like, six choices. I don't know if it's the full compliment of options that are out there. But one would be investing in product marketing for the business segment; two, would be accelerating the fiber investments for the mass market footprint; separating the assets between ILEC and business or fiber infrastructure from within business; pursuing partnerships or mergers to expand product and distribution; reducing net debt leverage more quickly; and aggressively reducing expenses. So, we'll come back to that as the audience has time to decide what they think the best way is. Happy to help. So, what are the big strategic decisions that need to be made as you've entered into this New Year and you're looking to reshape Lumen with the management team? Yes, it really starts with clarity of our plan, who are we? Who do we serve? What are our proprietary gifts and that yield a competitive advantage in the markets that we serve? We're calling that our North Star. And a big part of that is really the economic model. So, we've, obviously, got some businesses that are in decline with commoditization happening, and some legacy technologies. And creating a path forward to get to growth is job number one. And how do you do that, and where are the investments that we need to make that economic model is really informing a lot of that work. And if you put the North Star together with the economic model, you get a shortlist of core priorities pretty quickly. So, I'm pleased with where we are with that stream of work. We have great drafts across the board. So, we're making progress already. So, when I think Lumen, I think of all of the assets that this company has put together over time, particularly on the fiber infrastructure side. How can Lumen uniquely solve connectivity solutions for customers? So, I mean, I think we need to go back and first talk about those customers, right? So, one of our core priorities for the company is going to be to become customer-obsessed. That's a word that's often used in technology. I don't know that it's necessarily used in telecom as much. If you go back to our roots, that's not necessarily what you needed to do. You had an offering you brought to market and collect the rents off of those assets. In technology, you shape things to solve problems. And obsessing about customers' needs is the way that you drive innovation that drives differentiation that serves those needs. And that will be our number one core priority. It's where we're going to focus everything. And that will then inform our different pools of capabilities across core network services and connectivity. Continuing to make sure that we have the most unique routes, continuing to make sure we have state-of-the-art technology, lots of conduit out there, these are proprietary gifts that we have that we're really excited about. The trick is how do we drive more value from those assets, and that's the technology that we put on tap. Security is a huge opportunity for us. Edge Cloud, huge opportunity for us. And so, the other thing I've thought about with Lumen's history is, internally, there seems to have been a very significant focus on cost-cutting. And so, how are you thinking about pivoting the company from this historical focus on the cost cuts, and addressing some of the financial headwinds and become more growth-oriented? Yes. I think it starts with our mission, right? So, our mission is to digitally connect people, data, and applications quickly, securely, and effortlessly. The first part, connecting people, data, and apps, that's kind of our core DNA, right? Quickly, securely, and effortlessly, that's really what our customers are demanding of us to solve some of those core problems of delivering cost-effective operations, securing their data and applications, innovating themselves and helping their employees thrive, right? And so, if we think about our mission and how do we do those three things, quickly, securely, and effortlessly, to solve those core problems, you very quickly line up your investment engines behind what you need to do. Now, here's the challenge for us. We're the product of many, many mergers, right? And so, we've been looking inward for a long time about sort of how do we drive synergy, how do we take cost out, it was all about operational efficiency. When you look inward for a long, long time, you forget how to look outward. And that is a massive mindset shift that we're going to be working on as a company. We want to start thinking outside-in. I've mentioned we want to obsess about our customers and their problems, because that's how we drive innovation, which will be how we get to growth. You know what, I'm going to sort of just stick to my knitting, and say that we're going to be the best. Yes. So, think about turning the company to becoming customer-obsessed to creating the digital enterprise so that doing business with us is effortless. This is a big transformation journey. We need leaders who deeply understand how to drive change. And we also need leaders who deeply understand our core network services and all of the markets that we serve. It's a combination of some of the people who are here and have been for a long time and are super excited about the future. But it's also about bringing in new talent. And I -- look, I think about my job as, number one, super-clear strategic plan; number two, right people in the right roles; number three, capital allocation. And so, I'm really excited with the bench of tech talent that's been calling to say, "Hey, we'd love to help you with this transformation. Looks like a great opportunity." And today, we announced that Ashley Haynes-Gaspar is going to be our Executive Vice President of Customer Success, Wholesale and International. And I've worked with Ashley at GE and Microsoft. She's a change leader like I am, and knows how to deliver impactful results, and is one of the most customer-obsessed people that I know. So, I'm excited, she's a great addition to the team. And I think you'll see, over the next couple of weeks and months, we're going to make several more announcements just like that. So, 24%, invest in product and marketing for the business segment; 16%, accelerating fiber investments for mass market; another 16% for separating the assets in some way; and 44% reducing net debt leverage more quickly; zero for the partnerships, and zero for aggressively reducing expenses. As you're thinking of the plan and the mission, are you thinking about some or multiple options here? Well, I mean, I'll take you through my first draft of priorities, and maybe we'll sort of bump it up against that list and see where we land. You game? All right. So, the first thing is, develop customer obsession. I've talked a lot about that. That's building a muscle that will serve us well for growth. Once we figure out what those customer challenges are that we can grow into, I think the next thing is to innovate and invest for growth. Building that innovation engine, we have a couple of programs in the hopper that are going to help us with agile development around how to innovate quickly so that we can make sure that we're on the right path to putting product out there. But investing for growth, these are parts of the company that have been starving for a long time. Sales and marketing, when you're operational efficiency-focused you tend not to spend nearly enough on sales and marketing. And if you think about some of the technical capabilities being introduced into these markets, we really have got to put some dollars behind that. The next thing is building a reliable execution engine. I want the say-do ratio for this company to be at least 1:1. And what that means is doing less things, but doing fewer things so much better than we've ever done before. And that's everything from product invention, to launch, all the way through the lifecycle, to selling and supporting customers. So, you'll see us really fine-tuning our execution engine there. We need to radically simplify the company. And that's not only about stopping certain things and doing less and getting better at fewer things, but it's also about kind of shutting things down because there's sprawl. Again, operational efficiency, every dollar looks good, so you go out after a lot of different things, and you end up not getting them to scale, and they consume precious resources. So, I want all of the resources aligned behind the programs and projects that will help us digitally connect people, data, and applications quickly, securely, and effortlessly. And then, finally, we're going to make sure that we invest in our culture, transforming our mindset from inside thinking to outside thinking. Is part of -- when you talk about the simplicity, is part of the issue here that, from a systems perspective, from a function perspective, that Lumen may still be a company of companies, and that you need to bring that together? That's a huge factor in this for sure. And so, it's simplifying our IT real estate and preparing it for modernization and driving the digital enterprise, reducing the number of applications that we support and use, which will, by the way, be a big part of our operational efficiency journey. We're going to continue to optimize for cost, but we're also going to optimize for growth, and we're going to do that together. And when you think about the foundation of what Lumen is and what attracted you to the company, are there unique differentiated or underappreciated assets that investors should be mindful of? Definitely. So, our core network, the crown jewel, it's state-of-the-art, and it has unique routes and lots of conduit, and we have invested billions over decades in that. But the trick is getting the most amount of value out of that as possible, which is, I think, using technology to deliver solutions that solve those customer problems that I talked about. And I think two parts of our portfolio where we have tremendous gains, in Edge Cloud and Security. So, we help nations protect against bad actors, and that's relevant at the enterprise level and at the consumer level. And so, you'll see us leaning into commercializing those capabilities more and more. Black Lotus Labs is our threat detection and prevention research lab. It's world-class in terms of thought leadership and also in terms of practical solutions to help secure your data and applications. And I think it's like the best-kept secret in the world. So, I'd like to tell the world about it, and then to actually commercialize it. And so, you'll see me sort of coming back to those two areas a lot because they're underappreciated in the market. And as you're thinking about this product menu and you're thinking about offering customers a broader array of security options and Edge options, how do you think about the need to own these products versus partnering and almost creating more of a marketplace where you could just deliver a broad array of customized solutions? Yes. So, back to your little survey there, I think one of the places where we differ is I am a firm believer in a large partner ecosystem. And we are going to invest there, and let me tell you why. Partners are great for two things. Number one, helping you build out the complete portfolio, because there's no technology company that actually has it all. In fact, that's not a thing. There's not a single customer that wants one vendor because that's too much risk. So, building great partnerships that are deeply strategic, where your technology is better together, that's a story of scale. And that's what we're going to -- to grow, that's what we need to do. So, we'll be looking for pieces of technology that augment our portfolio to solve those customer problems that I keep coming back to, which by the way, huge opportunity in terms of solving customer problems today. They have all the same ones they used to be, but on top of that, the hybrid workforce, remote and in-person is changing the game. It's more complex and it's lots of change, that's an opportunity for a company like ours. So, reaching out into lots of different partnerships, whether it's with the UCC providers, like Microsoft, Zoom, and Cisco, whether we're talking about SASE, with VMware and Fortinet, whoever it is or the hyperscalers, they'll be important to our portfolio of capabilities discussion. There's another side to this, which is feet on the street. And so, having a cadre of partners that -- channel partners for sure, but also ones that bring a value story and help service partners that I could never have enough field-facing employees to cover those parts of the market. Two things: partner for growth in terms of go-to-market, and partner for growth in terms of intellectual property, and we'll be looking at the combo platter, which is all about our story of growth. So, right as you were arriving, Lumen cut the dividend. And as you're thinking about your priority stack, should investors expect a significant change in capital allocation and investment levels to realize the opportunities that you're outlining? Yes. So, I was an integral part of eliminating the dividend. And as I looked at this opportunity to lead this great company and to get to a place of growth, I knew that we couldn't do that. We would simply not have enough money to fund ourselves in the way that we need to in order to grow and compete in today's market. So, I'm really comfortable with where we landed on that. And now, we have the capital to be able to invest for growth, and you're going to see us do that. But we also have other capital allocation priorities that we need to take care of, and we'll be balancing through, and again, one of these -- I think it was C on your list, just in terms of staying net leverage neutral, right? But long-term, we'd like to bring our debt down, but right now we want to keep it under four times, and supporting our stock with buyback when we see valuation disparities. And balancing between the two of those, but growth is job one. You mentioned buybacks, so the question we're going to get, I think, from investors is, as you think about that, is that something people should think about near to medium term? Or should they think about it longer term once you make these investments and start turning the company and getting back to the growth objectives? So, we have a two-year $1.5 billion buyback program approved by our Board. And we are going to be super thoughtful about how we do that, and again, look for the disparities and bump it up against our allocation priorities. So, it's an evergreen process. When can Lumen begin to profitability grow business in wholesale revenue? So, we are going to give a few choices, 2023; 2024; '25 or beyond; or no visibility on when Lumen can return the segments back to growth. So, as that's populating in… As -- yes, as it's brewing, we are getting responses, maybe we will turn to the macro. I mean, Lumen touches so many parts of the economy, both for consumer and business customers. Are you seeing any changes in customer behavior with respect to pipeline, decision-making for sales, and just in terms of the behavior of those customers? Yes. So, our pipeline has been pretty stable throughout the year. We are happy about that. It looks good. When you talk about approval processes, in this economy, it's super challenging. And you are always going to have enterprises making sure they have the right approval processes in place. So, think about it as layers of administration on top of any spends that they do. And what's the one thing they are looking for? They are looking to make sure that whatever the executive is going to buy, whatever the division is going to buy, is going to solve those existential priorities or problems that I keep talking about. Reliable and core operations and securing your data and applications, that's existential for any CEO, including me. And so, our job, number one, is to make sure that we have the business case and the story of how we help them deliver those business outcomes or solve those challenges every single time we pitch. When you are operational efficiency focused and you are looking in and you come from a history of being a utility many decades ago, that's not necessarily a forte. So, we will be building that muscle and addressing that head-on that our technology can actually deliver great outcomes for companies in any market, especially a market that's down because technology can often help solve those problems and take cost out. And as you think about that, there is the possibility of recession this year, but there is also a substantial change in digital transformation for companies in accommodating a hybrid workplace that developed during the pandemic and just hasn't existed really prior to that. So, do you think even if the U.S. goes into recession, is there more opportunity because of the digital transformation and the migration to hybrid work in the security solutions and cloud solutions and Edge that's needed from all of that? So, I think it's from where you come from. I come from technology, right? And so, the technology world, technology is purchased during down cycles to help strengthen companies coming out of those cycles. And those are opportunities with this company just like any other one. And we will be very thoughtful about how we go after that. I think when you think about the hybrid workforce, people wanting to work from but also needing to come in, that represents change. We love change. Change is complex in this world with these giant enterprises and they need help. They need the high touch. They need us to help them think through how to deliver those business outcomes and that's what we do. So, while I am cautious because pressure is pressure. And we have got lots of it. And we have got a lot of work to do. This is something that we can flex our muscles and bring some of these great leaders in that I talked about that know how to do this and can help guide us. And are you seeing anything on the mass market sides? We are talking about more business just in terms of behavior -- customer behavior. You have got your quantum product in the market. You have got some legacy products. What do you see out of that segment from an economic perspective? So, inflation, basically, we announced in our last call that we will about a $100 million hit to EBITDA in 2022 mostly in the back half of the year, that's from an enterprise perspective. There is going to continue to be cost pressure going into 2023. We will use our operational efficiency initiatives to offset that pressure. But, it's there and it's real. And so far, it looks it could potentially continue. I think from a mass market's perspective, what we are seeing is that while it's little bit of an increase to our target cost per enablement, it's not materially affecting the notion of the lifecycle value for customers, which is the good news out of that. Our product is extremely strong. I love our NPS scores. I actually had to triple click. Not double, not single, but triple, quadruple click to look into them because they are so good. And it's exciting. And I think we can learn a lot from how we are serving customers digitally in that business. So, more to follow there. The question is when can Lumen begin to profitability grow business in wholesale revenue? 3%, 2023; 17% 2024; 47%, '25 and beyond; and 33%, no visibility. And of course, we would welcome you to weigh into your selection for survey. When you think about the business in wholesale side, maybe to think a little bit more about the revenue opportunities, can you help unpack how you view competitive position? We were talking about a little bit earlier. But what are the most compelling opportunities to profitability improve your market share? So, think about -- I keep going to back to this mission statement, because I am trying to help clarify who we are. We digitally connect people, data, and applications quickly, securely, and effortlessly. Why is that important? Because applications power the global economy. And data is the currency of those applications, right? And so, we are incredibly relevant in today's economy for the growth story of the macroeconomic environment for any enterprise. And so, we are deeply relevant. We've got a lot of change that's being introduced as I said. Now, where do we have muscle? So, we were incredibly thoughtful and very strategic when we decided to go into edge. And I think the world once thought we're going to be all public cloud all the time. And then, they looked at the reality of sort of retailers, the reality of manufacturers, healthcare companies, et cetera, and edge is a big part of how you need to connect people, data, and applications. The proximity of our edge capabilities to most businesses is extraordinary and is unparalleled. And so, we are excited about that. You are going to see us building and partnering to bring technology to the edge that is going to be differentiating. And we are going to be very clear on how we solve those unique problems of customers at the edge. So, that's one place where I have a lot of confidence that we can flex our muscle there. And then the other part is where I talked about security where we are doing some really special things to protect our network and to help the government protect the country. And all of that is translatable to both protecting individuals at the consumer level as well as enterprises. So, super unique gifts, undervalued, and we are going to be leaning into them heavily. So, just to unpack the edge a little bit more, because the word edge is something that's used by a variety of companies in the ecosystem. When you are thinking about delivering edge services, can you just give us a brief overview of what that might look like? And in terms of the sales opportunity, what can Lumen do differently to invest in the sales and go-to-market to take advantage of this opportunity? Yes, sure. So, I think just -- the way to summarize edge is latency slaying power, period. So, if you are putting cream filling in a cookie and you need to adjust the line, you cannot wait for that data to go up to the public cloud and come back. You have to use either on-prem or edge in order to provide the latency slaying power to get the cream filling in the right spot. Big cookie girl by the way. But, it's actually a manufacturing story. And that's my point is that as we become customer obsessed, we will continue to deeply understand the problems that manufacturer, retailers, healthcare companies, et cetera are trying to solve. And we know for a fact that our edge is in the place where it can slay latency for those types of use cases and business outcomes that those customers are seeking. Because we have got unique routes, because we did the calculus a long time ago to get to the right spot all across North America, and we are within less than 5 milliseconds of 97% of businesses, and nobody can make that claim. So, we are excited. And so, from a go-to-market perspective, how much of this a direct selling opportunity versus using channel partners and indirect and solutions providers to help get your fiber and your connectivity and your solutions into the hands of these customers? It's a good question. When you are first coming into a job, you sort of look left or right about what do we do? And what do we do well? And what do we need to work on? And I was surprised at how little we appreciate the partner ecosystem. Because the partner ecosystem is, as I said before, I will never be able to hire enough sales and marketing people be on the street to be able to cover the markets the way they need to be covered. And so, we have points of accountability at the -- for serving the commercial enterprise, leaders serving public sector, and then, now, for the first time ever, a leader running the team to serve SMB and mid market. And the reason why that's important is because in the old days, way back in 2022, basically mid market was embedded in our sales teams. And if you are a sales person trying to make your quota for the year, you are naturally going to go after the bigger deals to get there as quickly as humanly possible so you can get to your accelerators. The bid market motion is completely different than the enterprise motion. And so, it got starved a little bit in the process. Now, we see a huge opportunity there to invest and go after that segment with the right leadership. And it's going to 100% depend on our ability to build and nurture a partner ecosystem to help us cover those customers. When you talk about the large enterprise, commercial, public sector, they want high touch, they want reputation, which we have. They want deeply technical capabilities and managed services and they want state-of-the-art network. And we have all of that. So, we will maintain the face-to-face for those segments. But the place where we need just scale and go quickly, they are looking for simpler offerings, they are looking for no touch, they are looking for digital service across the entire customer lifecycle, we will be using partners heavily in those scenarios. Maybe shifting back to the mass markets in quantum fibers. So, big decision last year to -- or actually over the last couple of years to accelerate fiber upgrades inside of the footprint. And then, I think in the fourth quarter, there was some discussion about maybe a pause in revisiting some of these mass market strategies in terms of the timing the fiber. Can you walk us through sort of what's happening in terms of the quantum builds? And what the pause is solving for? Sure. So, the pause is really about figuring about how we can drive maximum shareholder value, period. So, we were very focused on counting, building enablement, that was sort of how we decided -- that was our success metric. As many as possible, more is always better. And the reality is quantity not always better than quality. Delivering quality enablements is a better story around driving profitable revenue. So, every dollar coming in the door greatly exceeds our cost of capital. And so, placing the emphasis there on quality is a different approach. And so, that was the sort of pause or thoughtfulness that we are applying to this. So, the numbers of pure enablements decrease when you do that. Two things that we are doing to ensure that we are speeding up, because we know that speed is important as well. Number one, I streamlined maybe, I think, it was week two, the organization under one leader. So, Maxine Moreau is President of Mass Markets at Lumen. And she has got full accountability from the P&L left to right, top to bottom. And what that meant is I took the operation's organization out of a unified, enterprise and consumer group, and I put it under her. It takes away any competing priorities for deployments. It takes away any organizational friction that might be there. And it gives us a streamlined org that's fully accountable and can go after this business in a way that they should with the speed that they should. The other thing is we are spending time building a factory approach to this. So, everything we do we got to do at scale. And we have got to be mindful from counting the number of buildings that meet the criteria of quality, all the way through to the deployments and making sure that the way that we buy is getting the best rates, but also the fastest deployments and then all the way through sales and marketing, and making sure we are hitting our penetration rates and doing so with the highest NPS scores in the marketplace. Seems like over the last year or so, there's a little bit of a surge in terms of the interest of different players in fiber infrastructure, whether it's upgrading or overbuilding. And part of this is under the bucket of whether we need -- or within the bucket of whether we need converged services for households of fixed and mobile broadband. What do you think is creating this interest for overbuilds and for potentially more fiber? And is there a concern that some of these overbuilds can hit your markets and create a less favorable competitive landscape? Yes. So, the interest -- let's talk about the interest first. The interest is there because it's a good business, albeit capital intensive, that's why you're seeing a lot of joint ventures. So, that said, we believe that there is an advantage to being the incumbent in these markets. So, when you're the incumbent and you have an existing fiber network, you've got technical capabilities, you've got facilities, you've got employees that can help you get up and running really, really quickly. And we're leaning into that advantage. That said, going fast and being first mover, there is always an advantage to that. And so, we want to do that more often than we have been. And that's why I talked about streamlining the organization and building that factory approach. So, you'll see us taking our incumbent advantage and putting it together with first mover, and good things are going to happen. Is outside capital an opportunity for your fiber initiatives? Or given that you think it's a good business model, would you rather retain 100% of those economics? And how do you look at wireless as an important tool in the toolbox, whether it's for the enterprise business or for the mass market business? So, I mean, I think if you think about fixed wireless, there are opportunities in some of these really complex enterprise deployments that I talked about, manufacturing, floors, et cetera, et cetera, where there's a bit of a better-together story. But if you're talking about fixed wireless opportunities for sort of down market, it's -- we're seeing a little bit of that in the rural space, but mostly for copper customers that are choosing speeds of 20 megabits per second or less. And their standards around symmetric of upload and download and the speeds and the reliability, it's just fundamentally different. And our Quantum product, we are maniacally focused on those metro areas where the standards are super high, our product is great, and we can get the return for shareholders. And do you have a view on mobile? Whether mobile would be accretive to -- even though it might be a resale, just accretive to the market share opportunities whether it's in the enterprise or in consumer to get a better share of what you make money from? Final question, so as we look into 2023, now that we're here, what are the near-term opportunities that you see to drive towards Lumen's goal of achieving this profitable revenue growth that we were talking about earlier? Yes. So, we're -- I mean, it's -- look, I was brought in from the outside, I'm a change leader. We're in a reset mode. We need to do lots of basic things to position ourselves to take advantage of the opportunity that's before us. And we will be doing all of those things with great speed. You will see us doing -- as I said before, we're going to do fewer things, and we're going to do them really, really well. And positioning ourselves from a mindset perspective around customer obsession and putting customers at the heart of everything we do, simplifying the company, driving the digital enterprise with automation and workflow, using data and AI to get great at maintaining the network and driving efficiency there, and innovating and investing for growth, that's this year. We're standing up all of those programs so that we can execute reliably and deliver the return that we know we can and should to our shareholders. That's what '23 looks like. So, I'm excited. We got a -- the team is coming together really, really well. And I'm looking forward to sharing more of the story with you in the coming months. Well, Kate, thank you so much for sharing your time with us. And we look forward to hearing more in the future too. So, thank you.
EarningCall_1458
Good morning and thank you for joining us for RPC Inc.’s fourth quarter and year-end 2022 financial earnings conference call. Today’s call will be hosted by Ben Palmer, President and CEO, and Mike Schmit, Chief Financial Officer. Also hosting is Jim Landers, Vice President of Corporate Services. At this time, all participants are in listen-only mode. Following the presentation, we will conduct a question and answer session. Instructions will be provided at that time for you to queue up for questions. Thank you and good morning. Before we begin our call today, I want to remind you that in order to talk about our company, we’re going to mention a few things that are not historical facts. Some of the statements that will be made on this call could be forward-looking in nature and reflect a number of known and unknown risks. I’d like to refer you to our press release issued today along with our 2021 10-K and other public filings that outline those risks, all of which can be found on RPC’s website at www.rpc.net. In today’s earnings release and conference call, we’ll be referring to EBITDA, which is a non-GAAP measure of operating performance. RPC uses EBITDA as a measure of operating performance because it allows us to compare performance consistently over various periods without regard to changes in our capital structure. We’re also required to use EBITDA to report compliance with financial covenants under our revolving credit facility. Our press release today and our website provide a reconciliation of EBITDA to net income, which is the nearest GAAP financial measure. Please review that disclosure if you’re interested in seeing how it’s calculated. Thanks Jim, and thank you for joining our call this morning. 2022 was an exceptional year, and we finished the year with very strong results in the fourth quarter. I would like to start by thanking our employees for an outstanding 2022. Their hard work and dedication in overcoming many challenges made our success possible. We look forward to building on our achievements and expect continued success in 2023. RPC’s fourth quarter financial results showed very little impact from weather-related or holiday downtime. Furthermore, our customers continued to work throughout the fourth quarter with no evidence of budget exhaustion. Although oil prices have recently moderated from their highs, they remain above levels sufficient to motivate our customers to drill and complete new wells. While pressure pumping is certainly a core business for RPC, we are much more than just a pure play pressure pumper; in fact, we are one of the very few companies that can provide nearly all of the services required to complete oil or gas wells. This diversification represents a competitive advantage for RPC and adds value as a leading provider of completion services for our customers. Our CFO, Mike Schmit will discuss this and other financial results in more detail, after which I will provide some closing comments. Fourth quarter revenues increased by 4.9% to $482 million from $459.6 million in the prior quarter due to improved pricing in most of our service lines and higher equipment utilization, supported by a full quarter of operations for our most recently reactivated pressure pumping fleet. Cost of revenues during the fourth quarter decreased slightly to $308.6 million from $309.8 million in the prior quarter. As a percentage of revenues, cost of revenues improved to 64% from 67.4% in the prior quarter due to improved job mix and continued strong pricing for our services. Selling, general and administrative expenses were $38.2 million in both the fourth and third quarters of 2022. During the fourth quarter of 2022, RPC also recorded a $2.9 million defined benefit pension plan charge related to a lump sum settlement offered to plan participants. During Q1 2023, we expect to record a settlement charge of approximately $22.5 million associated with the final termination of this plan. Also in connection with the transfer of the plan liability to a third party, RPC expects to make an approximately $10 million cash contribution also in the first quarter of ’23. Operating profit during the fourth quarter increased by 21.9% to $112.3 million from $92.2 million in the prior quarter. EBITDA increased by 19.8% to $135.5 million from $113 million in the prior quarter. Our technical services segment revenues increased by 5.1% to $458.1 million. This segment generated $110.5 million of operating profit compared to $89.5 million in the prior quarter. The improvement in operating results were driven by higher customer activity levels, improved pricing, and a larger active fleet of revenue-producing equipment. Support services revenues were unchanged during the fourth quarter of 2022 compared to the prior quarter. Operating profit, though, was $6.7 million compared to $5.3 million in the prior quarter. Now I’ll discuss our current year--sorry, our current quarter results compared to the same quarter in the prior year. Revenues increased to $482 million from $268.3 million. Operating profit increased to $112.3 million from $20.1 million. EBITDA increased to $135.5 million from $39.4 million. These increases were driven by higher customer activity levels and improved pricing, resulting in our diluted earnings per share improving to $0.40 compared to $0.06 in the same quarter of the prior year. Our technical service segment revenues increased 80.1% to $458.1 million, and segment operating profit increased to $110.5 million from $20.5 million in the same quarter of the prior year. Our support services segment revenues increased 73.1% to $23.9 million and segment operating profit increased to $6.7 million from an operating loss of $373,000 in the same quarter of the prior year. Now I’ll briefly discuss our capital expenditures and horizontal pressure pumping fleet count. Capital expenditures were $49.3 million in the fourth quarter. We currently estimate full year 2023 capital expenditures to be approximately $250 million to $300 million, including a new Tier 4 dual fuel fleet we plan to place into service during the second quarter, at which time we expect to take down an existing fleet for refurbishment. During the fourth quarter, we operated 10 highly utilized horizontal pressure pumping fleets. We expect to continue operating 10 horizontal fleets throughout 2023. Our confidence in the current industry outlook along with our view of how that should translate to our financials has encouraged us to make investments in our completion-oriented businesses. Previous up-cycles have resulted in our industry adding significant capacity, inevitably outpacing demand. In contrast, our current focus is on long-term investments to maintain and selectively improve our current productive capacity, also to generate leading industry-leading returns on invested capital and leverage technology to perform our services in an environmentally friendly manner. Through a combination of dividends and open market share repurchases, RPC has returned over $536 million to shareholders over the last decade. As evidence of our confidence in the strength of the current cycle and commitment to our shareholders, we announced this morning an increase in our regular quarterly cash dividend from $0.02 to $0.04 per share. A few things from me, if you don’t mind. I guess the first is when you look at the current pressure pumping market and what you see in the industry dynamics, we think, and I think there’s a lot of people out there who are sort of sensing a much different approach by operators as far as adding assets, etc. In the field, what do you see? Is your experience similar to that, and maybe talk a little bit about how you think about new build economics right now. Yes. Stephen, this is Ben. I think that there is investment that’s taking place. I think more than whether there’s investment taking place is ultimately what the overall capacity equation is going to look like. We’re working really hard to--or we’re committed to a plan to--as I indicated in my comments, we’re trying to more or less maintain our existing capacity, but we’re upgrading that, we’re making investments where we need to, to make sure that we can continue to provide a quality service. But we want to utilize our existing equipment, right, and get as much out of it as we can. If it can generate adequate returns and provide a quality service, we don’t want to take it out of service too quickly, but then we have the long lead times for new equipment, so getting the timing right between when an existing fleet will be ready to retire or lay down, right, that’s tricky, and that’s not something we’re trying to necessarily say those are going to happen on precisely the same date. But we’re really looking at--you know, we’re committed to trying to generate free cash flow during this particular cycle. As I indicated, we’ve returned a lot of cash to shareholders over time. Our history shows that we’ve done that, and we continue to be committed to that. So our--and return, you asked about our returns and the way we think about that, the return profile or what one would reasonably expect 12 or 14 months ago versus where we are today, obviously it’s completely different, right, so we don’t all of a sudden wake up and say, well, today or last month or last quarter, the return indications are unbelievable so we should ramp our spend or our investment. We’re trying to--we expect to remain disciplined, we want to go at an appropriate pace, having a longer term plan and try to execute against that plan, and allow us to take advantage of the opportunities, be there to provide services to our customers, maintain our existing capacity more or less, selectively grow but maintain our capacity, and focus on that continuing to return excess cash to shareholders. Yes, this is Mike. I’ll just add one thing to think about too. When you order new equipment in pressure pumping, right now there could be up to a year lead time, so you’re making a huge financial commitment and betting on what the market is going to be a year from now. That’s the other consideration that’s worth thinking about, capital allocation to capex. And Stephen, one last thing. We have been in a period of under-investment for a very long time, probably since 2015. At this time, the market for--the drilling rigs and the completion demand has pretty much soaked up the available frac spreads, and back to Mike’s comment, it is going to take a while to catch up with that. People do seem to be being disciplined at this point - that’s always subject to change in our industry, but there is a level of discipline that we haven’t seen before. Nobody’s stood up in the canoe yet, so we’re--we believe that we’ve got a good runway here. The other two quick ones, you mentioned the delivery of the new Tier 4 DGB, and then I think you said you were going to take an existing fleet out and refurbish it. Is that fair? Will that go to work, or does it just depend on timing and demand, and has there been any trouble getting the necessary parts to refurb the asset? The refurb--yes, we’ll refurb it so that it can come back to work. When the brand new fleet comes in around the same time, we’ll take down one of our older fleets that we’ll spend some money and upgrade it, and once it’s upgraded, we expect that will be--there are other fleets that need to be either refurbed or otherwise dealt with, so as we indicated, we’re expecting still to have 10 horizontal fleets working--more or less 10 horizontal fleets working throughout 2023, with the gives and the takes of ones going down for refurb and that sort of thing. Supply chain, still we’ve been managing through that. We have some good vendor relationships and it’s always a challenge, but we think we’re in pretty good shape with that. We won’t know, obviously, until it’s completed. We are concerned, but we’ll stay on top of it and make sure that it gets turned around in a time frame that we’re planning on. But we’re working through that and we’re confident that our schedule and our plan will allow us, as I said, to continue to operate around 10 horizontal fleets throughout the year. Thank you, and then just one other quick one. Jim, do you mind just running through the segment breakdown by--the revenue by product line? For the fourth quarter, the percentages I’m about to give are the percentages of each of our largest service lines as a percentage of total or consolidated RPC revenue. The largest service line--the largest revenue for the fourth quarter was pressure pumping at 56.9%. The second largest was down hole tools at 20.8%. Number three was coiled tubing at 8.4% of consolidated revenues. Our nitrogen service line was 2.3% of consolidated revenues--I’m sorry, I got out of order there. Rental tools, which is in our support services segment, was 3.6% of consolidated revenues. We’ve seen a little bit of moderation in the gas rig count. I just wonder if that is affecting pressure pumping at all, and to take that a step further, we’ve heard that there’s a little bit of weakness in the gas plays but the assets are finding a home in the oil plays. Can you broadly just talk about your pressure pumping calendar and is there any shifting between the plays as of late? Don, this is Jim. Your point is a good one. I would say not yet, because there is still so much--you know, demand is still greater than supply. I would say if there’s anything regarding the natural gas market weakness, it’s more an opportunity cost than anything else. I mean, when you have no white space in the calendar, something that might have happened in the future but isn’t going to doesn’t impact near term results. This is Ben. I’ll add a very large percentage of our activity is directed towards oil wells, and it’s just been that way. We’ve not consciously made the shift. We’ve been talking about it, but have not made a conscious shift to try to move assets or focus on the primarily gas basins as of the [indiscernible]. Okay, I appreciate that color. One more from me. You called out pricing in the fourth quarter as one of the reasons why you outperformed consensus expectations. How broad-based was that, and was it more skewed to pressure pumping or coil, and can you just kind of run down how pricing has been across two or three of your segments? Relative to--talking about the fourth quarter results, I don’t know that there was--I think the increases in pricing has been sort of a steady process over the last quarter or two. There wasn’t--we had some nice wins, especially with the new fleet we put into service in the fourth quarter. It went to work at a nice--it was a good piece of work for us. There was not a tremendous increase in the fourth quarter. I think the fourth quarter was driven as much by efficiency. The fact is, as we indicated, there was very little fourth quarter normal slowdown, number one; and number two, though, it was just a good job mix that wasn’t quite as hard on our equipment, and we were able to be really efficient. There was minimal white space, as there has been in earlier quarters, so I think it was just a combination of a good job mix, good efficiency on those jobs that we were working on, just overall good execution. The guys have done a tremendous job taking advantage of the opportunities that have been presented. Okay, and one final one from me, do you have any major contract rolls as we move into the first quarter? I don’t know if, you know, had quarterly openers or whatnot on your contracts, but any significant pricing uplift from contact roll expected in the first quarter? By the nature of our portfolio, no; but we are continuing to work on pricing, but there’s no specific whatever event or contract rolling, that would have an individually significant impact, but we do see some additional improvement opportunity as we move forward. I have a quick question on the capex budget. I think you said 250 to 300 is the guide for this year, and if my monkey math is correct, you were around 140-ish for ’22. I’m curious, within that capex budget and aside from the one fleet that you have on order, is there any additional new equipment orders that are anticipated in that budget or is that all maintenance? Yes, and certainly maintenance capex. There’s not any other significant new builds, and part of the make-up for--you know, there’s a lot of things that go into how much you spend on capex, not only the commitments you make but the timing of when the equipment is ready and delivered and all of that sort of thing, so some of the number that we’re talking about in ’23 are some delays from ’22. I think our capex came in a little bit lower than we had, quote-unquote, indicated earlier. But we’re comfortable with the level of spend, and no, there’s not any other significant certainly capacity increases that are there, and that fleet we’re taking here in the current quarter too is not a capacity increase, as we’ve talked about. We’re staying around that 10 operating fleet. Fair enough. I know on the new fleet, you said dual fuel Tier 4. I’m curious, as you look at the other parts of your business, because you said it in your opening remarks, you’re more than just frac, is there any effort for fuel electrification, whether it be on wire line or coil? Anything in the other segments? Not to any significant degree. That technology is something that we’re certainly trying to watch and monitor. We do have an opportunity coming up to take--to utilize an electric pump within the hydraulic fracturing service line, but it’s more of a dip the toe in than put in all the chips at this point. Last one for me, and not to be a nervous Nelly, but we have had a few guys, E&P contacts tell us that they’ve started to ask for relief in light of the gas price coming back, etc. I’m curious--and they’re not widespread anarchists, by the way, but what’s your message to your guys when that first request comes in to RPC about granting relief? Do you tell your guys to tell the customer to pound sand, or what’s your message going to be to them once those requests start coming in? Well, our guys in the field don’t need to be told what to do, they understand. But there are other opportunities, and I think that too helped, other customer opportunities. I think there is confidence at this point in time that we do have some alternative choices. Now, it’s not--you know, that can take some time and that can be disruptive, but I think their response at this point in time would be--you know, our customers are important to us and there may be other ways to maybe give some relief, but it might be maybe you increase your activity or whatever, right? But we would look to try to find a way that we would not step backwards. We need to continue to move forward with respect to our net pricing that we’re getting, pricing and utilization. And I’ll add, our costs have gone up significantly as well and continue to, with all the capital investments and maintenance. We’re not really getting any relief on those fronts either, so, and there’s a lot of demand. Hey, good morning. I just wanted to get your thoughts on attrition. I mean, I don’t think we’ve really seen attrition in an upcycle if we look over the past couple decades. You’re obviously bringing in a new fleet, you’re going to take one off to the sidelines and refurb it, and I think that’s a form of attrition. Pumps staying on the sidelines longer, could maintenance swings have extended out due to supply chain, maybe beefing up your current fleet going from 50,000 horsepower to maybe 60,000-plus. Would just love your take on what attrition is today, all the different parts of it, because I think that’s one thing that’s being underestimated by the broader market in why frac supply is going to stay tight through 2023. This is Ben. We obviously don’t have direct visibility into our competitors, we can only speak to what we see, and yes, the activity levels are very high. Much of the work is, or a lot of the work can be very, whatever, damaging, difficult on the equipment. As I indicated, in the fourth quarter we had some nice work that wasn’t quite as difficult as some previous quarters, so that can vary some from quarter to quarter. Our guys are doing great work trying to forecast out if this amount of activity with this type of work, when might the appropriate time be to take a fleet either completely out of service or send it off for refurb, and things like that. I think there is some belief, too, from some of our key operating personnel that attrition may be being underestimated, that maybe it’s going to be difficult. Now there is--as I indicated earlier, there is a lot of spending going on, there is a lot of new equipment orders amongst our peers, but there’s a lot of discussion about the fact that they too are not going to--they’re not striving for net additions to their fleet, so that’s implying that they plan to take some of that equipment out of service. But it certainly could happen. With what you’re saying, it could be that it’s being underestimated. I think everybody, or most everybody recognizes that it is real, and I think supply will remain tight. I guess the question being, how tight might it be if the attrition ends up being even higher? Yes, it will be great for those of us that are still working. Got it, that’s helpful color. Do you guys--a question on maybe some of your private peers. Are you seeing any new entrants coming in, just given where economics are, or are you seeing some of your privates maybe leaving? I know there’s been a few acquisitions. Just a sense on the private market, because I also feel like there is this narrative around private pumpers coming into the market and over-building, like we saw in past cycles, but would love to hear your view on this. We’ve heard some examples of some privates coming on, not to any large degree. What we tend to hear when we ask the question is that private equity is not coming in, in a big way, so that’s great. That to my recollection has been the issue in the prior two or three strong cycles we’ve had, that’s when private equity comes in big and--so. If they more or less stay on the sidelines or don’t come in, in a big way, hopefully we’ll be able to try and keep supply and demand appropriately balanced. I know you’re not going into e-frac markets yet, but I just wanted to get your updated thoughts on that. Are you waiting for that technology to be de-risked? The other day, the biggest pumper out there was talking about there’s obviously an adoption curve that everyone is trying to get up on. Would just love your take on what e-frac is, how you’re looking at it, how you’re being looking at the different examples of it, your view on coming up the learning curve, and maybe some of the challenges that some of your peers might face as they look to scale electric frac. We’ve heard examples of companies or situations where it’s been a struggle. We’ve watched it, we’ve studied it some. It’s not a tremendous focus for us, but we do have an opportunity just to take some--a pump, that we’re going to be able to partner with a vendor to be able to use that and do some testing for both them and for us, and that will help us along the learning curve, and them as well. We still at this point--obviously the new fleet that we have coming in early this year is dual fuel. I think the transition, just like other transitions of technology like this, will take a period of time, so there’s going to continue to be, I think, plenty of demand and strong demand for traditional diesel equipment more so--you know, the DGB, and so we’re moving in that direction. I foresee for the foreseeable future that the majority of our spending will be on the traditional equipment. I don’t see a shift in the near term for us to go to e-frac, but we are experimenting with it. We do want to learn about it. There may be some other applications on ancillary equipment that may benefit us, but in terms of a full fleet, for us that’s a little bit down the road, I think at this point. Yes, and Derek, since we don’t have firsthand experience, what I’m about to say may be wrong, but based on everything we’ve heard, the economics don’t yet work, so something else to think about. Got it, and one more, if I could just squeeze it in. Guys, can you give us a refresh on how many Tier DGBs you have now, or dual fuels? Can you give the breakdown of those 10 fleets in the different categories? Our active horizontal fleet has five ESG-friendly fleets, and that’s Tier 4 DGB, Tier 2 DGB plus five Tier 2 diesels. By the second quarter of 2024, we expect our DGB--or I’m sorry, our ESG-friendly composition to be closer to 75%. We have two Tier 4 diesel, they’re not DGB but they’re Tier 4s, so it’s kind of a combination. So about half today of our horizontal fleets are very much ESG-friendly, and we expect that will move closer to 70% sometime in the next 18-plus months. As a reminder, if you would like to ask a question, please press star, one on your telephone keypad. We’ll pause just a moment. Thank you. We appreciate everybody who called in to listen today. We appreciate the questions and enjoyed the conversation. Hope everybody has a good day, and we’ll talk to you soon. This concludes today’s conference call. You may access the replay of today’s conference on www.rpc.net within two hours following the completion of the call. Thank you for your participation. You may now disconnect.
EarningCall_1459
I’m Mike Cikos, analyst with Needham on the infrastructure and analytics space. With us today, we have the management team from MongoDB. Michael and Serge, thank you very much for joining us. Maybe to start the fireside here, for folks who are brushing up on the name or newer to the name, can you kind of just walk through the value proposition here? What MongoDB is solving for your customers? And how you're differentiating versus other offerings out there? Sure. Yes. Maybe we'll just take a step back. The database market is one of the largest in all of software. So, the latest IDC numbers have the 2022 market at $84 billion and that's growing to $138 billion in 2026. So, very large market, but also actually growing at a fairly healthy clip. And so, one of the questions is why is the market so big and why is it growing too much? And I think it's really because this is sort of at the heart of this strategic nature of what software is all about. So, if you hear these phrases like software is eating the world or every company becoming a technology company, those are all shorthand for the fact that companies today are driving competitive advantage on the basis of their internally built technology, specifically, they're internally built software, right. Off the shelf software, it's actually a competitive advantage because everyone can go buy it into the way that our drive competitive advantage is [they go build] [ph] software. And every application that I build has a database at its heart, at the center of it. And that's really what determines the nimbleness, the speed, the agility, the scalability of your business. And so, people today are hiring developers. You hear about Wall Street Banks talking about having more developers than large brand name consumer technology companies and those developers are expensive. People want to get more out of those developers and so developer productivity speed and rate and pace of innovation is really where, you know we kind of come into play. The technology that sort of predominated previously is relational technology that was really built for a different era that was built for an era where storage was a big constraint. Storage was incredibly expensive in the 1960s and 1970s when relational technology was pioneered. That's now not the case. And so, we sort of help bring a different paradigm, almost a better mousetrap to help solve the challenges today. Happy to go in any of the details, if that's useful or interesting for folks, but that's really where our value prop resonates and the reasons why people are increasingly picking MongoDB. The other advantage in addition to, sort of having that developer mindshare is the general purpose nature of what we do. So, rather than being sort of a point solution or built for sort of a specific use case, we have this general purpose positioning that allows companies to ultimately standardize on MongoDB as their modern alternative. Why don't I stop there. I can go on and on. Yeah. Yeah. And if I just think about the market for a second, right. So, if we're talking about the IDC estimate, let's use that, so [85 billion] [ph] in 2022 going to 138 billion in 2026. Have you guys broken [that] [ph]? Like how much of that is locked up by incumbents? How much of that is still held by let's say the relational databases and how much of that growth is expected to come from non-relational databases? Yes. So, I'll say a few different things. So, I think the distinction in relational, non-relational is sort of interesting, but not relevant for us because we can serve all the different workloads. Many of the other folks who were challenging the incumbents came up with technologies that can only do certain things or have very narrow applications or, sort of work for a specific used case. So, we're a little bit different way. Obviously, industry analysts have to come up with some way if you're Gartner IDC or some way of like kind of describing or characterizing the market, but it doesn't tend to map our reality. So, we win and a healthy chunk of business from relational people who run into, if you're a customer and you're prospecting, you're running into challenge with scaling Oracle or one of the other traditional legacy players, MongoDB can be picked for that. So, it sort of underscores the fact that this sort of relational versus non-relational or relational versus no sequel sometimes is how it's referred to. It's not really the way the market plays out. So, how to think about the market maybe a quantitative exercise we can use. I mentioned that sort of 84 billion going to 138 billion over four years. That's a little over 13 billion of growth every year, right? So that tends to be new applications, new opportunities, people building new applications. And just for perspective, large organizations will have not just hundreds, but thousands or even tens of thousands of applications that they've built internally. And so, they don't tend to be just sort of one just sort of monolithic application. So, we've got 13 billion of new growth in the market a year and that 84 billion that exists, it's predominantly with the incumbents to your point. Doesn't do an RFP every year, right. Like, it can be working perfectly fine. And if it's working perfectly fine, there's no reason to go change it out. If just for simplicity sake amongst the group of us here, we say an average application is a 10-year life cycle. That means it's about 8.5 billion every year that's coming up for grabs. You marry that with the 13 billion, you've got sort of north of 20 billion a year that's kind of in play. From a technological standpoint, we at MongoDB can address that. I think one of the challenges that we have is developers are opinionated. They're smart. We've continued to evolve our product over time, but the MongoDB product today is not the same MongoDB product that it was 5 or 6 or 7 years ago. And so, if you experiment it with it back then, and we've got an open source component to what we do. And so, you're engaging with it in an uncurated fashion. You would have rather said, oh, well, it was good for this, but not good for that. We've subsequently addressed that from a technical standpoint, so there are no technical constraints for why you couldn't use MongoDB, but we continue to invest in sort of the awareness and perception of all the improvements that we've made. That's great. And one more on the market opportunity, but you just cited, let's say, this 10-year application life cycle, right? With the way that the world is shifting, is it fair to think that there's a collapsing of those life cycles and there's [Multiple Speakers] over time? I think that's right. I think of the 10 years is merely somewhat arbitrary and imperfect and we can have a whole session just debating how long that is, but I think there's no question that whatever the starting point is, they are shrinking, right. Those life cycles are called compacting and you're seeing higher velocity because just if you think about the way your expectations as a consumer of what – how you interact with applications, you bring that consumer mindset to your work mindset. So, even if it's not a consumer facing application, even if it's [B2B application] [ph], you expect to interact with things in a fast, easy, intuitive kind of way. And so, I think that's one of the many forces that’s sort of driving application life cycle shorter and ultimately making applications more – making applications smarter really and we benefit from that trend. Great. Shifting gears to let's talk end market demand, right, especially in the current macro. What has been some of the changes you've seen, whether it's customer adoption, customer growth in consumption trends? Can you just set the level there as far as the audience that we have today? Yes, sure. One of the things that we've tried to do is, sort of help break down the underlying dynamics that we've talked about, sort of winning new business and new workloads and then the performance of existing workloads that are on our platform and we found that to be a helpful way. Not just for us to think about the business, but also to share and communicate out with all of you. So, to date, we've not seen any impacts on terms of new business from the current macroeconomic headwinds. It's been pleasantly surprising to see. It's a testament to the product. It's a testament to the fact that we're in this big market and we're relatively small piece of the puzzle and it's obviously a testament to good strong execution. None of that of course precludes that from happening in the future, but to date, we really haven't seen those headwinds. We haven't seen the deal slippages or other things that some other software public traded software companies have talked about. We have seen an impact on consumption of existing applications. And that really relates to the fact of the consumption of Atlas, which is our databases service product. Directly mirrors the underlying end user activity with the application. So, it's really more of a second order effect of what we're seeing for our customers’ customers or our customers end users interacting with their applications. We've seen those grow at slower rates. We're still seeing growth within this, but we've seen those rates of growth grow more slowly. It's broad based. It's been across the board, across sector, across geo, and as we sort of map and triangulate and kind of slice and dice ties back to underlying slower macroeconomic activity. The last thing I'd say if you kind of try and tie the piece together, in the short-term, our results are more impacted by the expansion of existing workloads and or behaviors of existing workloads just given the size of the installed base, but over the medium to long-term, the much bigger factor is how many new workloads, how many new customers are we winning and so that kind of helps paint the whole picture. And on that last point, I do want to come back to the Atlas and consumption trends, but sort of, why do you think the new workloads has persisted as far as the growth? Like there's no change in new business you're seeing on those workloads, right. So, I'm just curious why that has persisted in this environment? Yes. So, I think there are a couple of things. I think that what we're doing is incredibly high value. So, there is a stock ranking, right, that people are doing in terms of what deals they're going to move forward with, where they're going to just spend money, people are being more selective about that. It doesn't mean we always win out, but I think in general, the problems that we're solving are at the top of the list for folks. And so, we've benefited from that and been able to execute well, sort of despite the headwinds. I would also say, it is a huge market and so even if there are pressures or even if IT budgets wind up coming under scrutiny or things like that were the vast majority of the time are share gainer, rather than an incumbent who's got a lot to lose. And then I think the third piece is we've done a good job from an execution standpoint. Our sales team is very focused on execution. We have even unrelated to today's current environment long standing views around pipeline qualification assessing things. I've heard some of these stories or examples or anecdotes that people have talked about with, you know, deal slippage or companies, customers prospects, introducing additional approval thresholds, previously, the CFO of company XYZ only needed to sign-off $1 million deals and they moved it down to $0.5 million deal because they're trying to provide scrutiny over the spend levels internally from the salesperson. That would be a terrible excuse, right. Part of your job as a salesperson in terms of qualifying a deal and getting a deal across the finish line is to understand the paper process at the customer, right. And so, especially in the current environment, it's very logical that people change their approval thresholds, do all those things all the time. And so, part of just the day-to-day managing of the sales process is being aware of that and getting ahead of that. So, internally, it wouldn't fly very well as an excuse to go figure that out. So, I'd [chalk it up] [ph] to our execution and our focus on to kind of rigorous pipeline qualification. Great. And for the Atlas consumption trends this year, right, during 2Q, I think they came in lower than there was a weakening in those consumption trends, right? And in 3Q, we did see an uptick. Can you talk about the various puts and takes that led to that and then we can start to talk about maybe some of the commentary you guys had as far as the guidance you had for Q4? Yes. So, I guess I'll start as at the end of Q1 and walk us through at a high level what happens since then and we can dive into any specific as a follow-up. So, near the end of Q1, we started seeing slower growth in certain parts of our Atlas business when it comes to growth of existing applications, specifically in Europe, specifically in our self-serve and mid-market business. And as we look to sort of the underlying dynamics behind that slowdown, it became apparent to us that this is a macro slowdown. And from there, we concluded that macro slowdowns, then not to be limited to a particular geography or particular segment, but then to be broader than that. So, we expected – going into Q2, we expected business to – consumption of outlets to slow down everywhere. And that's largely what happened. We saw consumption slowdown and we provided a relatively detailed sort of checklist of how we expected things to play out when we provided our guidance in our Q1 calls, so that would have been May. And then Q2 largely played out as we expected, but with some puts and takes. And most notably, and this was a significant topic of conversation with investors in time. The European enterprise business and our mid-market channel globally grew slower than we expected. There were other areas that were better, but those two came a bit lower than expected. So, fast forward to Q3, consumption did better in Atlas across the board than in Q2 and that wasn't what we expected and that wasn't implied in our guide. And there were two factors driving the improvement in Q3 versus Q2 as we understand it. The first is, based on how Q3 played out, we believe we benefited from seasonal strength in Q3 versus Q2. And the way we see that is that the back half of Q3 was better than the first half and similar thing happened last. And it was driven by the underlying usage of the applications and it was pretty broad based. And what we think is going on is, sort of a seasonal back to school, if you will or back to work after the summer phenomena where people engage with the applications in their lives more than they did during the summer. And we saw it last year, we're seeing this year, it’s only two data points because Atlas is a very young business still. So, we can precisely pinpoint and quantify the size of it, but we definitely think it was a factor in Q3 and we wanted to make sure we share. And then the second piece, which is over and above the seasonality, those areas they were particularly weak in Q2 or slower than we expected them to be namely European enterprise and mid-market, those did better. And what we think happened there is that those customers pause the investments in the growth of their applications because those were segments that were most immediately impacted by macro. Europe is – shouldn't be a surprise in mid-market also because those tend to be younger companies. And they went back to investing more in Q3 seems to us. Doesn't mean that it's like the new normal, doesn't mean that we [bottom ticked] [ph] it in Q2 and that Q3 is the right level to think about it going forward. It's just we wanted to make sure you understand that we did sell those two areas of improvement. One is seasonal and one seems to be more related to those specific segments. And just to close the loop on the seasonality, right, because I think during the earnings call, you guys called this an emerging seasonal trend, but to your point, Atlas was much younger if we rewind three years ago as far as its growth in its size. So, that's why we're defining it as being emerging currently right? You referenced those two data points, and that's really why we're citing that. Yeah. I don’t think the emerging is, you know, shorthand for like a current working hypothesis or something. Like, we don't have enough data points to sort of state it definitively or declaratively, but when we look at it and use our best judgment that seems to be a contributing factor. Is there anything to think about for that seasonality besides back to school or vacations or is that kind of it is for, it is the way… That's what we see right now because it was pretty broad based. So, yeah, we can't sit here, oh it's like prep for the holiday season or anything like that. It was it was pretty broad based in every geographies and across all industries. So, we think it's fundamentally the way people work with their apps. Okay. Okay. Also on the consumption, so you guys had specified that November, the consumption trends were, correct me if I'm wrong, about in-line with what you guys saw in Q3, right? But the 4Q guide implied, I guess, consumption growth [fee sales] [ph] from what we had November during December and January. And I'm guessing that's based on, again, typical seasonality, holidays, maybe fewer days in those months… It's not fewer days, it's literally the mirror image of what we saw, the strength in September, October, which is during the holidays people engage with apps [less] [ph]. Just less use. You do other things during the holiday. Is there a way to think – like, if I rewind a year ago when we were in January, February, I think the big thing, and I know we've all learned that consumption models are different, right, but like there was weakness cited from consumption models, from Datadog, from New Relic, [Confluent] [ph], like there was a host of consumption models that we're talking about, maybe developers were returning to work on a slower basis than what they'd historically seen. Maybe there was vacation angst coming out of COVID. Did you guys, if you rewind a year ago, did you see that? And has that in any way been incorporated into the Q4 guidance we think about? We did not see that a year ago. Nothing other than normal usage based slowdown is baked into the current guide because we see no reason as it moves parallels. Like you said, consumption sounds like it's all the same, but in fact, when you look under them, they're all very different. So, you got to be kind of mindful of what is the actual driver for each of those companies. Yes. I think in those examples, at least as I understood and as I heard people talk about them, they were describing internal behaviors within their company that were, you know, affecting things or internal behaviors within their customers. What we're talking about is, you know, their developers, you know, showing up people taking more vacation whenever. What we're talking about is, end user activity, right? So, this is not confined to our customer, but this is our customers’ customers, our end users. Consumers, if it's a consumer application, business users if it's an internal application. And so, it's just sort of a different, you know, dynamic than what others have. Okay. And a more basic question on the consumption about the pricing mechanisms, right? If I think about, let's say storage or compute or anything, like is there a way you can give us broad brushstrokes for how much revenue is being derived from each of those or do you not look at it based on different mechanisms? We don't look at it that way and the customer doesn't buy it that way. The way to think about it is, you have your application. It has a certain set of characteristics when it comes to reads rights, transactions, usage of data storage and so forth. And based on that, you pick the instant size that you buy. And that instant size is, sort of fixed until your application growth changes it. And for vast majority of customers, vast majority of the time the applications tend to grow. So, we think of it as sort of like a staircase of usage, whereas like you use a certain size of instance. As the application grows, you get to the point where you now need a bigger instance to provide the same type of performance and characteristics to your customers, so you upgrade. And as you, kind of move up that staircase, each individual customer has their own pace. And that kind of combined set of dynamics is what drives Atlas consumption. Great. And if I could just take another stab at it. If I'm thinking about the growth like, we're talking about new workloads versus existing workloads, right? Can you help us frame like, in a given quarter how much of the growth is coming from existing versus new? Has that relationship been relatively steady? And then in the current macro, are you seeing maybe existing workloads growing at a slower rate versus previous cohorts? Like how do we think about all those factors? So, I say a couple of things. Number one, in any given period, vast majority of growth comes from existing workloads. And there shouldn't be a surprise because new workloads, especially Atlas workloads, start very small. Most of what we do analysis, net new workloads are [indiscernible] start from zero. So, it really takes time for them to build and sort of make that impact. So, if you think in any given quarter and sort of in the near to medium-term, vast majority of growth is driven by existing workloads and that changes, but given the size of the base, it changes maybe slower than you would guess. So, existing workload is the meaningful driver for near to medium-term. To your second point though, it's also very important. Obviously, we get to look at the business, not just in totality, but also across cohorts. And what we've observed over the last couple of quarters Q3 improvement notwithstanding is that we've really seen a slowdown regardless of, sort of the age of the customer, right? So, it's not just like that like three plus year Atlas customers have slowed down, but it really across the board and yet again another reason to believe that this is fundamentally and exclusively a macro phenomenon. Yes, I would just add that all this consumption discussion is about Atlas, which this last quarter was 63% of revenue. The Enterprise Advanced business, which is the vast majority of the balance, does have 606 rev rec. It's affected by term license revenue. New deals can meaningfully change those numbers right out of the box. And so, just so people aren't confused by that. Great. And if I'm thinking about like the – I guess the customers on Atlas versus EA, have you guys spoken to, I guess, what's been the typical trend? Like, is there is there a typical customer as far as migrating from EA to Atlas over time? How much of that should we think about as being a source of growth or does it in anyway [canalize] [ph] the existing revenue? Is there an uplift in spend over time because of that? Yes. So, the typical pattern would be of an existing Enterprise Advanced customer who's adding additional workloads and decides that they've changed their view as it relates to public cloud. We run the business on a channel basis. We make – we want MongoDB to be easy for our customers to use regardless of their IT strategy. As much as people talk in conferences like this about Cloud, Cloud, Cloud, the answer is, not as many workloads are in the Cloud as you would guess. We're still relatively early on in that journey. There's certainly particular industries or companies that tend to be more less Cloud forward, more focused on, yeah, they either have regulatory concerns or other issues. But over time, what we've seen is, even within that customer base, which may be somewhat characterized a little bit more laggard or otherwise, starting to adopt Atlas workloads that tends to be for new workloads for MongoDB. We haven't seen a lot of behavior activity of someone taking an existing EA workload and moving it to Atlas. That certainly could happen or happen more over time, but unless someone's hitting or saying, I want to get out of all my data centers immediately tomorrow, I'm going to move everything. You typically sit here and say, I've got an application. It's working well. Like, why do I need to go move it? But you're looking for increased functionality, increased scalability, there are new applications or existing applications that aren't performing as well. Those are good candidates to move to MongoDB. And if you've evolved your posture around public cloud, maybe say, you know what, I'm going to start to put those in the public cloud. The last thing that I'd say, more broadly is, I think historically there's been this sort of temptation to think about even though we run the business on a channel basis, to think about EA customers as being, sort of laggard legacy types and Atlas folks being new modern. That's increasingly not the case. You can see increasing adoption of Atlas within enterprise customers for mission critical applications that shows up in the numbers and that's been great to see. We expect to see that happen over time. We're also increasingly seeing enterprise advanced customers thinking about as they expand their enterprise advanced footprints thinking about that as sort of a first step to cloud modernization because you can run MongoDB in any environment. Maybe they have regulatory other concerns about public cloud, but their engineering teams want to be modern. They want to have modern tools to appear to their engineering teams so they can keep their engineers satisfied. So, MongoDB can be really effective in that regard as well. And so, I don't think there's quite this, sort of universe that's divided into these two things, but over time, we're sort of obviously seeing more public cloud adoption clearly throughout. Maybe the last thing I'd say is because we were in the business on a channel basis, maybe it's helpful to think about the self-serve channel is basically all Atlas. The mid-market is – the vast majority is Atlas. And so ultimately, the MongoDB product mix will be determined by enterprises and how quick do large Fortune 500 Global 2000 folks adopt public cloud. Great. And another point really to, kind of accentuate the difference in consumption models, but optimization is something that's come up from folks. Like, are you guys facing headwinds from customers trying to optimize their usage of MongoDB? It's not a phenomenon that really affect us. And the best way to think about it is that we are very – in fact in the beginning of our conversation, we're very well aligned with our customers. So, they’ve built the app, they invested their precious developer resources to create this thing. And then how much the app grows and how much that app interacts with the database and therefore how much that grows as the app grows is really fundamentally what drives how much they spend with us. And they want to see the app successful. And when the app is successful, they aren't surprised that as a result, they have to pay us more. And just like all of us and with everything in our lives, given two prices for the same thing I prefer to pay less. But ultimately, paying us more is a sign that what they invested in the first place was successful. And so, we're happy to have that alignment with them. Yes, I think about the key factor being even though people think of consumption as the common trend and therefore there being such a thing as a consumption business, I tend to think of consumption more as a revenue recognition model and the business model is really about what is the value relative to what you're charging. And so for us, we've got this very tight linkage between what we're charging for is based on the end user activity of the application to which – to Serge’s point, they've spent money to go build. They want that to be successful. And so, we have this very tight linkage that doesn't really lend itself to some of those dynamics that seem to be affecting other folks. And another question on, I guess if we shift from Atlas to EA, can you help us think about like, I think EA has demonstrated outperformance almost every quarter versus what people were expecting? What's driving that outperformance this year? Is there any common trend as far as why we're seeing that strength? You're right. EA has been the source of upside in every quarter so far this year and Q3 was no exception. Whereas Atlas obviously the trends have been mixed and we talked a little bit about that. When we think about EA strength, at the end of the day, it's a lot of the same drivers that we talked about when it come to the whole business and Michael sort of ran through this, but first of all, it's a large market. And we have low share, even in our existing customers. We believe we're the best technology. And we have strong go to market execution to go identify new workloads in our EA customers to continue growing. And so far at least, despite the macro environment getting more challenging, where you would think you would hurt EA more, right, because there you have to sign a contract, pay upfront more often than not, we've really just been fortunate because of the size of the market and our ability to execute to not see a dramatic or any really macro impact on the EA side so far. I would just call out for those who missed it, that was a friendly modeling tip that next year we’ll have tough compares for EA throughout all the quarters. All right. And I know I still have a set of questions here. I'm going to go through maybe one or two more and then turn it over to the audience if you guys have questions as well. On the profitability, if I rewind, I guess it was two quarters ago, I know management sounded a tone that you guys were definitely trying to invest because you find your win rates go up when you have a seat at the table, which makes sense, right? Fast forward to 3Q one quarter ago, there was a meaningful lift in the operating margins. And some serious demonstration of leverage. Can you help us think about what drove that Q3 upside? I think there was revenue outperformance. I think OpEx even declined sequentially? And then how should we be thinking about management's willingness to trade-off growth versus profitability in the current environment? Yes. So, I'll run through a few things. First, specifically for Q3, to your point, we did have significant revenue outperformance and that flowed through the bottom line that obviously demonstrates the operating leverage that exists that hasn't always been the case in the sense that we've had revenue outperformance, but it hasn't always flowed through the bottom line. So, it's not just exclusively revenue outperformance. I think we're conscious to, I won't quite say competing trends, but there are at least things that are in our thought process. One is, we are trying to run the business for the long-term. We've crossed over 1% market share, closing it on 2% market share, have a tremendous product, have unbelievably strong unit economics, all these other things. So, it makes sense to keep investing in the business for the long-term and for the benefit of long-term shareholders. That said, we're highly conscious of the current environment. And so, I would describe it as like our investment philosophy, our investment framework hasn't really changed, but we've updated the inputs. It would be irresponsible not to reflect the inputs. What that means is effectively is a higher cost of capital. That means if you have a set of projects, even if they're all very high return projects, fewer of them clear the bar if you raise the bar, right? And so that's really been the dynamic and the thought process internally. Specifically to the sequential decline, it's probably worth calling out that Q2 is always our highest quarter in terms of marketing and sales spend. We have our big annual user conference We have some of our excellent clubs and other sort of awards events in Q2. So, we were always going to see a sequential decline Q3 relative to Q2. You'll note though that the sequential decline was not just in sales and marketing, but you also would have seen that in R&D. Part of that also though is that people from our R&D team do also travel to that global annual user conference. But I do think it's worth saying there is incremental scrutiny on expenses both of, sort of discretionary measure, T&E and things like that, but also just on the returns, right. And looking at and saying, if the cost of capital has gone up, our return threshold needs to be higher, different things, not everything clears the bar, not things that used to clear the bar, don't clear the bar anymore. That's been a very active conversation and process internally. The last thing that I'll say, which is maybe helpful in terms of adding a little bit of context or color is, we're always trying new things, right? I mean, part of the way that we've driven the success and the progress that we've had in the go to market side is by tweaking that go to market. It's not stagnant. It's not the same playbook. It’s not the same motion that we've had that we've just been so cranking out at ever increasing scale. Unbalance those experiments, those initiatives, those pilots have had a very positive effect, but not every single initiative is successful. And so, another way that the current environment plays out on that is if you had an initiative, and you're a couple of quarters into the data and the data isn't playing out in the way that you're expecting, you're not kind of clearing the bar so to speak. I think in a lower cost of capital environment, you'd say our intuition tells us that should work, let's give it another couple of quarters, right, whereas in the current environment and a higher cost of capitalization [indiscernible], you know what, our intuition told us this should work, we now have some data, the data shows it doesn't work, maybe we need to [stop] [ph] doing this, right. So, I think that's a little bit about how we're thinking about things. I think at a more macro level, if you sort of take a step back, we continue to run the business for the long-term. We do have this very large market that we're going after. We have exceptionally strong demonstrated product market fit. We're delivering high rates of return. The cost of capital has certainly gone up, so fewer things clear that bar, but we'll keep taking that long-term view. I think in our life as a public company, we've got something like over 35 percentage points of margin improvement. This last year was another 100 basis points of that. We obviously haven't given fiscal 2024 guidance, but we've been pleased with that progress so far. If I think about this year with that expansion in operating margin to call it a 100 bps of improvement this year, right, I think at the start of this year, management had guided to an incremental $45 million to $55 million in post-COVID normalization expenses for like let's say MongoDB World, right? Are we still charting the course for that 45 to 55? Is that still expected this year? Kind of question about competitive landscape, you talk a lot about your [indiscernible] competition against the incumbents, but curious whether you're seeing any meaningful head-to-head competition from other document database [indiscernible]? And kind about the second point, when you look at the overall [TAM] [ph] of NoSQL databases generally how do you think of the growth of applications, that's leveraged document databases versus other types of notes [indiscernible] value or perhaps the underlying standard [indiscernible]? Yes. So, a few thoughts. One, I don't think we've seen any fundamental changes in the competitive scape over the last couple of years. Our win rates are exceptionally high against all flavors are big challenges, because the market is so large and our footprint coverage is so thin just not being in conversations, but whether it's versus relational, non-relational MongoDB imitators, whatever it is, we have exceptionally high run rates really across the board. I think to the second point of the question, I sort of alluded to this a little bit earlier at the beginning. I don't really think from a competitive standpoint or from, sort of a product standpoint, it's super helpful to think about the universe in terms of relational versus non-relational or relational versus NoSQL. At least as it relates to MongoDB, just because we can handle the whole universe of situations. So, the beauty of the document model is, the document model really is a superset. And so, you can do key value. You can do graph, you can do, you know, whatever you need to do within that, and that's part of the reason why time series, you can do whatever you want to do. And so that's why we've been so successful is because of the general purpose nature of what we do. So, we don't – yes, you can find very niche specialized used cases that would benefit from a highly specialized database, but on balance for the vast, vast majority of workloads, we've got the breadth and variety to cover, sort of all those situations. And so, I was reminded earlier this morning at one of the investor meetings, when I first joined the company 7.5 years ago, there's a whole slew of players, couch-based [indiscernible], all these other people. And we were all roughly the same size. We were anywhere between kind of $20 million and $40 million, and we've obviously broken out and kind of separated ourselves from the pack. And it's because everyone saw the big market opportunity, but we had a better technology that's delivered against this multipurpose positioning that drove the developer affinity that we have, right. And so, that's sort of developer mindshare, that developer fondness that we have. And then we married all that with good execution. And so, as a result, we're sort of meaningfully bigger and kind of growing faster than all those other players. Just from a customer's perspective, what is the cost savings on moving their workload forward to you guys over short-term, long-term? Yes. So, the cost savings tends to be valuable and significant, obviously in today’s market environment is particularly top of mind, but cost savings doesn't tend to be the primary reason why people pick MongoDB. They tend to pick it so that you can innovate more quickly or drive scale and innovation at scale. So that tends to be, sort of a secondary or tertiary consideration. That said, there is significant TCO. The beauty is back to the developer fondness is, we see such increases in developer productivity, as well as just general efficiency in terms of running and operating MongoDB that most of the savings comes from other sources. So, we don't even need to be deflation area at the license level. Obviously, we've got the opportunity to be, but that doesn't tend to need to be an area that we need to go to because there's so many other sources of cost savings. That said, I think if your sole goal were cost savings, there are cheaper alternatives. And so, again, it goes back to the first point, which is, we tend to be brought in when you've got a really big problem. You're running into scaling or other challenges with Oracle or with your other existing legacy player. And so, you need that scalability, the nimbleness, the agility, and the ability to innovate more quickly. That tends to be the primary driver because that'll be cheaper solutions if you're solely cost focused.
EarningCall_1460
Ladies and gentlemen, thank you for standing by. Welcome to the 3M Fourth Quarter Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded, Tuesday, January 24, 2023. Thank you, and good morning, everyone, and welcome to our Fourth Quarter Earnings Conference Call. With me today are Mike Roman, 3M's Chairman and Chief Executive Officer; and Monish Patolawala, our Chief Financial and Transformation Officer. Mike and Monish will make some formal comments, then we'll take your questions. Please note that today's earnings release and slide presentation accompanying this call are posted on the home page of our Investor Relations website at 3m.com. Please turn to slide 2. Please take a moment to read the forward-looking statement. During today's conference call, we'll be making certain predictive statements that reflect our current views about 3M's future performance and financial results. These statements are based on certain assumptions and expectations of future events that are subject to risks and uncertainties. Item 1A of our most recent Form 10-K lists some of the most important risk factors that could cause actual results to differ from our predictions. Please turn to slide 3. Please note throughout today's presentation, we'll be making references to certain non-GAAP financial measures. Reconciliations of the non-GAAP measures can be found in the attachments to today's press release. Before I hand the call over to Mike, I would like to take a moment and highlight of financial reporting change we are making starting here in Q1 2023. As we announced in our press release on December 20th, we'll be exiting PFAS manufacturing by the end of 2025. As a result, we have decided to provide additional disclosure by expanding the scope of our non-GAAP measurement adjustments to include the exit of PFAS manufacturing. For 2022, we have treated the Q4 PFAS manufacturing exit cost as a special item in arriving at results adjusted for special items. However, beginning in 2023, we will expand the existing adjustment for special items to also adjust for the sales and estimate of income and associated activity of PFAS manufacturing. Therefore, our outlook for 2023 reflects this adjustment. Today's press release, press release attachments and slide presentation provide information regarding our 2022 performance on our existing Q4 2022 non-GAAP basis, along with some comparative information on the new 2023 outlook basis. We will be providing a Form 8-K during the first quarter to reflect additional effects of this change in our non-GAAP measures and changes in segment reporting. We remain committed to providing strong transparency in reporting our financial performance. And of course, we are always here to address your questions. Thank you, Bruce. Good morning, everyone, and thank you for joining us. We continue to focus on delivering for our customers and shareholders in a challenging economic environment with slowing growth, inflation and supply chain disruptions. We posted organic growth of 0.4% versus our expectation of 1% to 3%, along with adjusted margins of 19% and adjusted earnings of $2.28 per share. The slower-than-expected growth was due to rapid declines in consumer-facing markets, such as consumer electronics and retail, a dynamic that accelerated in December, as consumers sharply cut discretionary spending and retailers adjusted inventory levels. We also saw a significant slowing in China due to COVID-related disruptions, along with moderating demand across industrial markets. As demand weakened, we took actions to adjust manufacturing output and control costs, which enabled us to deliver a $250 million inventory improvement. In addition to actions taken in the second half of last year, today, we announced restructuring in our manufacturing operations, as we expect the demand trends that we saw in December to extend through the first half of 2023. I will discuss this more later in the call. With supply chain stabilizing, we are focused on improving manufacturing operations and driving working capital. These are our most significant opportunities to improve margins and cash flow. As we navigate the external environment, we continue to position 3M for the future by investing in growth, productivity and sustainability. I will recap 2022 and our outlook for 2023 after Monish takes you through the quarter. Monish? Thank you, Mike, and I wish you all a very good morning. Please turn to slide five. As you will recall, we highlighted negative trends in our consumer retail and electronics-related businesses in late November. As the fourth quarter progressed, those trends accelerated. We also experienced significant slowing in China as COVID-related impacts resulted in a 17% decline in organic sales in December and down 8% for the quarter. Health Care continued to be challenged in its recovery to pre-pandemic levels, given labor shortages and hospital budgets being under pressure, while industrial end markets mostly remain steady. Fourth quarter total sales were $8.1 billion or down 6.2% year-on-year, which included headwinds from foreign currency translation of minus 5% or $400 million, which is better than the minus 7% we had expected. We also experienced a 1.6% decline from divestitures, or nearly $140 million, largely from the third quarter divestiture of food safety, along with the deconsolidation of Aearo Technologies. On an organic basis, fourth quarter sales increased 0.4% versus last year. This result included an anticipated falloff in disposable respirator demand and the exit of our operations in Russia. These two items, combined, negatively impacted organic sales growth by approximately $230 million or 2.6 percentage points. Excluding this decline, Q4 organic sales growth was 3%. On an adjusted basis, fourth quarter operating income was $1.5 billion, with operating margins of 19.1%. Adjusted earnings for the quarter were $2.28 versus $2.45 last year. Turning to the components that impacted fourth quarter operating margins and earnings year-on-year performance. We took a number of actions to navigate the fluid and slowing macroeconomic environment, including managing selling prices to address inflationary pressures, reducing manufacturing output, maintaining strong spending discipline and taking additional restructuring actions to streamline the organization and adjust to slowing end market demand. These actions delivered an underlying benefit to operating margins of 110 basis points and $0.19 to earnings. This helped more than offset headwinds from the sales decline in disposable respirators and Russia exit, which negatively impacted operating margins by 70 basis points and earnings by $0.15 per share. Inflation continues to impact raw material, logistics and energy costs. These pressures remain persistent and are broad-based. In Q4, raw material cost increased approximately $110 million or a negative impact of 1.4 percentage points to operating margins and $0.16 to earnings. As mentioned, foreign currency translation was a negative 5% impact to total sales. This resulted in a headwind of $0.10 to earnings per share, however, was a benefit of 10 basis points to margins. Divestitures, primarily Food Safety, along with the deconsolidation of Aearo Technologies, resulted in a year-over-year headwind of $0.04 to earnings per share in the quarter. Finally, other financial items increased earnings by a net $0.09 per share year-over-year driven by lower share count, partially offset by a higher tax rate. Please turn to Slide 6. Fourth quarter adjusted free cash flow was $1.7 billion, up 3% year-on-year, with conversion of 131%, up 18 percentage points versus last year's Q4. During the quarter, we aggressively adjusted manufacturing production levels to end market trends, which drove a sequential reduction in inventory levels by $250 million. For the full year, adjusted free cash flow was $4.7 billion with adjusted free cash flow conversion of 82%. Capital expenditures were $506 million in the quarter and $1.75 billion for the year, or up 9% year-on-year as we continue to invest in growth, productivity and sustainability. Looking to 2023, we expect capital expenditures in the range of $1.5 billion to $1.8 billion, which includes approximately $200 million of investment in water stewardship related to our exit of PFAS manufacturing. During the quarter, we returned $1.4 billion to shareholders through the combination of cash dividends of $820 million and share repurchases of $540 million. For the year, we returned $4.8 billion to shareholders, including $3.4 billion in dividends and $1.5 billion in share repurchases. In addition, we reduced our outstanding share count by 16 million shares via an exchange offer associated with the Food Safety divestiture. Having a strong balance sheet and capital structure remains a priority for 3M, because of the flexibility it provides. Net debt at the end of Q4 stood at $12 billion, down 4% year-on-year with net debt-to-EBITDA at 1.4 times. Please turn to slide 8 for our business group performance. I will start with our Safety and Industrial business, which posted sales of $2.7 billion or up 1.3% organically. This result included a year-on-year headwind of approximately $165 million due to the ongoing decline in demand for disposable respirators. Excluding disposable respirators, Safety and Industrial grew Q4 organic sales by 7.5%. Our Personal Safety business declined mid-single digits organically, primarily due to the decline in disposable respirator demand. Turning to the rest of Safety and Industrial. Organic growth was led by low double-digit increases in electrical markets, automotive aftermarket and abrasives. Industrial adhesives and tapes and closure and masking systems both declined low single digits. Operationally, the Safety and Industrial team drove strong execution during the fourth quarter. Adjusted operating income was $611 million, or up 9% versus last year. Adjusted operating margins were 22.4%, up 2.7 percentage points as the team managed inflation with price actions, drove yield and efficiency and exercised strong spending discipline, while also investing in the business. Moving to Transportation and Electronics, which posted sales of $2.1 billion, or up 1.4% organically. Our auto OEM business increased mid-teens versus a 2% increase in global car and light truck builds. We continue to gain penetration on new automotive platforms, while also benefiting from a favorable comparison due to last year's Q4 channel inventory drawdown. Our electronics business declined 10% organically as it continued to be impacted by the significant end market weakness particularly for smartphones, tablets and TVs. Turning to the rest of Transportation and Electronics. Advanced materials grew organically low double digits, while both commercial solutions and transportation safety increased low single digits. Transportation and Electronics delivered $366 million in adjusted operating income, down 3% year-on-year. Adjusted operating margins were 17.8%, up 60 basis points versus Q4 last year. The team was able to more than offset manufacturing productivity headwinds and inflationary pressures with ongoing benefits from pricing, along with strong spending discipline and restructuring actions, while investing in the business. Looking at our Healthcare business, Q4 sales were $2 billion, with organic growth of 1.9% versus last year. Sales in our medical solutions business declined low single digits organically. Fourth quarter elective health care procedure volumes were approximately 90% of pre-COVID levels as nurse labor shortages and strained hospital budgets continue to impact the pace of recovery. Oral care was up low single digits despite decreased consumer spending on discretionary items. And finally, separation and purification organic sales increased high single digits while Health Information Systems was up mid-single digits. Health Care's fourth quarter operating income was $421 million, down 18% year-on-year. Operating margins were 20.6%, down 2.9 percentage points, with adjusted EBITDA margins of nearly 29%. Year-on-year operating margins were impacted by manufacturing productivity headwinds, increased raw materials and logistics costs, along with investments in the business. These headwinds were partially offset by pricing actions along with the strong spending discipline. Lastly, our consumer business posted fourth quarter sales of $1.2 billion. Organic sales declined 5.7% year-on-year with particular weakness in the US, which was down high single digits. All businesses declined organically as consumers pull back on discretionary spending and retailers aggressively took actions to reduce their inventories, particularly in the US. Looking ahead, we anticipate those trends to continue at least through the first half of 2023. Consumers fourth quarter operating income was $224 million, down 24% compared to last year, with operating margins of 17.9%, down 3.3 percentage points year-on-year. This year-on-year decline in operating margins was driven by increased end market weakness, higher raw materials and logistics and outsourced hard goods manufacturing costs, manufacturing productivity headwinds, along with investments in the business. These headwinds were partially offset by selling price actions and strong spending discipline. I'll now turn it back over to Mike for a recap of our full year 2022 performance. Please turn to slide nine. Thank you, Monish. 2022 was a pivotal year for 3M. Throughout the year, we took decisive actions that are foundational to our future and at the same time, maintained our focus on our customers. We addressed inflation through selling price actions and proactively managed cost as demand softened throughout the year. To address supply chain disruptions, we did what was necessary to serve customers and reduce cycle times, including opening a new distribution center on the East Coast. We navigated COVID-related lockdowns in China. We reached agreement with the Flemish government to restart operations in Zwijndrecht and exited our Russia business. As always, we put 3M science to work to solve customer needs across our market-leading businesses. In Safety and Industrial, our new robotic paint repair system received multiple prestigious honors, as we continue to drive innovation in automotive manufacturing, an area we led in for more than 100 years. In Consumer, we launched Scotch cushion lock, a sustainable alternative to plastic wrap, which was recognized by Fast Company as one of its world-changing ideas. In Health Care, we advanced our leadership in wound care, which includes our negative pressure wound therapies, becoming the first solution of its kind to surpass 2,000 peer-reviewed studies. In Transportation and Electronics, we introduced new thermal barrier films to improve performance of electric car batteries, one element of our $0.5 billion automotive electrification platform, which delivered 30% organic growth in 2022. Company-wide, for the total year, we delivered organic growth of 1%, or 3% excluding the impact of disposable respirators and our Russia exit. We posted adjusted EPS of $10.10, along with adjusted free cash flow of $4.7 billion with an adjusted conversion rate of 82%. We strengthened our balance sheet and reduced net debt by $0.5 billion, ending 2022 with a net debt-to-EBITDA ratio of 1.4. This enabled us to invest in the business and returned $4.8 billion to shareholders through dividends and share repurchases. At the same time, we took actions to position us for the long-term. We divested our Food Safety business, receiving $1 billion and reducing our outstanding share count by 16 million. We continue to progress in our health care spin-off, which will create two world-class public companies better positioned to drive growth and value creation. With respect to combat arms litigation, as last week's report from the Chapter 11 co-mediators indicated, 3M continues to support Aearo Technologies in this ongoing confidential mediation process. We continue to address PFAS litigation by defending ourselves in court or negotiating resolutions as appropriate. We also announced we will exit all PFAS manufacturing by the end of 2025. Our decision is based on careful consideration of the external landscape, including regulatory trends and changing stakeholder expectations. We simplified and streamlined our supply chain organization and advanced our digital strategies to better serve customers. We followed through on our sustainability commitments. We are ahead of schedule installing state-of-the-art filtration technologies and factories around the world. We now have capabilities up and running at all three of our largest water using sites in the US and in centric [ph]. We supported employee health, safety and well-being, including new flexible work arrangements and factory investments and we advanced diversity, equity and inclusion, with each of our business groups now executing initiatives. The steps we took in 2022 and the steps we are continuing to take in 2023, position us well as we look toward the future. Please turn to Slide 11. We expect market and macroeconomic challenges to persist in 2023. Based on this outlook, we expect organic growth of minus 3% to flat, along with adjusted EPS of $8.50 to $9, and adjusted free cash flow conversion of 90% to 100%. Our expectations reflect the slowing in demand we are seeing as we start 2023. Supply chains are improving. However, we still see headwinds from material availability and inflation, albeit at a lower level. We are not satisfied with our progress or performance. We are taking additional actions, building on the actions taken in the second half of 2022 to reduce cost structure and inventory. We have implemented strict control of hiring and discretionary spending. Today, we announced that we will reduce approximately 2,500 global manufacturing roles, a necessary decision to further align with adjusted production volumes. In addition to the actions we are taking to respond to the macroeconomic environment, we are taking a deeper look at everything we do as we prepare for the Health Care spend. As we move through the year, we will take additional actions to improve supply chain performance, drive simplification and bring us even closer to our customers. At the same time, we win in the market because we stay close to customers and continue to invest in innovation even in the most difficult times. We will continue to invest in growth opportunities in our businesses, aligned to global trends that take best advantage of our innovation. Automotive electrification, industrial automation, biopharma processing and home improvement are just a few examples of large, fast-growing markets where we are investing and where 3M innovation can make a difference. We will continue to prepare for the spin-off of our Health Care business, which presents a tremendous value creation opportunity while at the same time, preparing 3M for future success. We will work to resolve litigation we face following through on the actions we initiated in 2022. Underpinning all of our work will be the strengths of 3M, our people, our industry-leading innovation, our advanced manufacturing, our global capabilities and our iconic brands. I am confident in our future as we exit 2023, we will be a stronger, leaner and more focused 3M. Thank you, Mike. Please turn to slide 12. The macroeconomic environment remains very fluid and uncertain. For 2023, we anticipate that GDP and IPI will continue to moderate with both currently estimated to be around 1.5% or about half of 2022 levels. Therefore, against this backdrop, we feel it prudent to set our expectations to reflect this reality. As Mike mentioned, we estimate our full year adjusted organic sales growth to be in the range of minus 3% to flat. This includes selling prices up low single digits. Therefore, organic volumes are expected to be down low to mid-single digits for the year. This range also includes an estimated two percentage point headwind from the ongoing decline in disposable respirator demand, along with the impact of our exit from Russia. We currently expect our disposable respirator demand to be down to pre-pandemic levels. As the strength of the US dollar carries into 2023, we estimate a foreign currency translation impact to sales of minus 1% to minus 2%. And divestitures that were completed in 2022 will be a headwind to sales of nearly one percentage point. Adjusted earnings are expected to be in the range of $8.50 to $9 per share. This range includes a combined earnings headwind of $0.55 to $0.80 per share year-on-year from the following three items. First, the expected sales decline of disposable respirators and exit of Russia will be an impact of minus $0.30 to minus $0.45. Second, foreign currency will be a headwind of minus $0.10 to $0.20; and third, divestiture impacts would be a minus $0.15. In addition, the 2022 carryover impact of higher raw material and logistics costs, combined with energy inflation, creates a year-on-year headwind of approximately $150 million to $250 million or roughly $0.20 to $0.35 to EPS. And finally, non-operating items are estimated to be an impact to earnings per share of flat to minus $0.10. This range includes a year-on-year increase in non-operating pension expense of $125 million. A full year adjusted tax rate in the range of 18% to 19% and a lower year-on-year outstanding share count. While there are a number of headwinds to earnings in 2023, ultimately, our full year performance will be driven by organic sales volumes, sustained progress in global supply chains and raw material availability, and our ability to drive improvements and reduce costs in our manufacturing and supply chain operations. Finally, full year adjusted free cash flow conversion is forecasted to be in the range of 90% to 100%. This range includes the continued healing of global supply chain, expected improvements in working capital performance, particularly inventory reductions and full year capital expenditures of $1.5 billion to $1.8 billion, which includes approximately $200 million of investment in water stewardship related to our exit of PFAS manufacturing. Please turn to slide 13. Looking at our expected performance by business. We see Safety and Industrial organic sales growth to be down low single digits in 2023. This includes an estimated decline in disposable respirator sales of $450 million to $550 million or a negative impact of approximately four percentage points as the business returns to pre-pandemic levels. Demand across industrial end markets is moderating as customers remain cautious. Our Safety and Industrial team will also be monitoring the recovery of industrial production activity in China as we start the year. Adjusted organic sales growth for Transportation and Electronics, excluding the impact of the exit of PFAS manufacturing is forecasted to be down mid-single digits to flat organically. Looking across end markets, automotive unit volume production is currently forecasted to be up nearly 4% year-on-year. We also expect automotive electrification trends to remain strong as we leverage our technologies and develop new innovative solutions for our automotive OEM customers. Electronics, however, is expected to be down significantly due to weak end market demand for TVs, tablets and smartphones, along with the ongoing impact of display technology shifting to OLED from LCD. Healthcare's organic sales growth is anticipated to be up low to mid-single digits versus 2022. We expect gradual improvement in healthcare elective procedure volume as nurse labor shortages and strain hospital budgets continue to impact global healthcare systems. In oral care, we will be monitoring consumer discretionary spending and its impact on patient visits, including orthodontic care. The Healthcare team continues to create differentiated value and deliver strong margins for the attractive end markets we serve. And finally, organic sales in consumer are estimated to be down low single digits to flat as US consumers remain cautious and retailers continue to aggressively reduce the excess inventory levels. Despite these near-term challenges, the consumer team remains focused on leveraging our iconic brands and accelerating new products in 2023. Please turn to slide 14. Before we go to Q&A, I want to walk through how we are seeing the first quarter. First, three weeks into January, we are seeing continued slowing in organic sales volume as we start the year. This slow start is driven by the same weakening end market trends that impacted the finish to 2022. We expect soft consumer discretionary spending, along with retailer destocking to continue into the first quarter. Sales of electronic devices are forecasted to be down between 10% and 30% sequentially in the first quarter, while semiconductor end markets and automotive builds are down mid-single digits sequentially. Health care and oral care elective procedure volumes are expected to be at the same levels as Q4. And as we have noted, industrial end markets are mixed. And we anticipate the ongoing COVID-related challenges to continue in China and the geopolitical situation in EMEA to persist. Therefore, taking all of these items into consideration, we estimate Q1 total adjusted sales in the range of $7.2 billion to $7.6 billion versus $8.5 billion adjusted for the exit of PFAS manufacturing or down 10% to 15% year-on-year. This anticipated year-on-year decline includes headwinds of 3 to 4 percentage points from disposable respirator sales declines and Russia exit, 3 to 4 percentage points from foreign currency translation, and 1 percentage point impact from divestitures. Taking these factors into account, we expect Q1 organic sales to be down low single digits to mid-single digits. From an EPS perspective, we estimate that first quarter adjusted earnings per share will be in the range of $1.25 to $1.65. This range is impacted by the continued slowing of organic sales volumes, a pre-tax restructuring charge of $75 million to $100 million or $0.10 to $0.15 per share, a tax rate of approximately 19%, along with normal Q1 items. As you can see, the first quarter presents a tough start to the year. We will have our most challenging year-on-year comps related to the declining disposable respirator demand and our exit of Russia. Ultimately, organic volume trends will be the biggest factor in determining how the quarter will turn out. 2023 is an important year as we work on progressing our strategies, including preparing for the spin off health care, improving our manufacturing and supply chain operations, and taking actions to further streamline the organization. We are focused on creating the shortest path to the customer and providing innovative solutions to their most challenging problems. We will remain nimble and take appropriate actions as we respond to changing market dynamics. And we will continue to invest in growth, productivity and sustainability to ensure the long-term success of our enterprise. To wrap up, I continue to be bullish on our long-term trends. The large and attractive end markets we serve provide exciting opportunities for the future of 3M. We are not satisfied with our performance and the expected start this year. We are working to aggressively address our operating performance in this challenging environment. We expect organic sales volumes will improve as consumer retail and consumer electronic markets stabilize. China works through its COVID-related challenges and as our year-on-year comps ease. We also expect supply chains to continue to heal and raw materials and logistic cost headwinds to abate. Therefore, we anticipate improvements in organic growth, operating margins, earnings and cash flow as we progress through the year. As you've heard me say before, there is always more we can do and we will do to improve our performance. I want to thank our customers and suppliers for their partnerships and the 3M employees for their hard work and dedication as they continue delivering for our customers. That concludes my remarks. We will now take your questions. I was hoping you could walk us through, just perhaps logistically or opportunistically, how you exit PFAS. It's so integrated with your with your product line, your manufacturing systems. Can you sell some facilities? Can you extract some value, or is it -- or do you just have to close -- lock up the facility and walk away? And how does that work logistically? Yeah, Scott. So maybe I'll take you back to the announcement of the exit. We said we'll exit all PFAS manufacturing by the end of 2025. We also said we would work to discontinue use of PFAS in our products broadly across the company. That's both in our products, but also in the manufacturing of our products. And I think your question is really on our manufacturing part of that. And we said we will meet contractual commitments that we have to our customers, and we're working closely with them to manage that as we make this transition. But ultimately, also, I talked about that we are not planning and won't sell the businesses and that we will plan to shut them down as we work through the transition as we get to the end of that -- end of 2025. Scott, just also a reminder, as we disclosed, we said we would take -- the exit cost of this will be in the range $1.3 billion to $2.3 billion. And we took a fourth quarter charge of $800 million, that's included in that range of $1.3 billion to $2.3 billion. Okay. That's helpful. And then you talked about doing some further restructuring, perhaps help us understand the scope or scale, or at least are you talking about -- I think you mentioned 2,500 people. But are the rooftops and meaningful cost out that you see in this plan? Yeah, Scott. So the announcement we made today was 2,500 jobs in manufacturing, really is responding to the volume that we see, the outlook for the volume. And that's -- we're putting a focus on supply chain. We see an opportunity to continue to streamline our supply chain. We hope to take advantage of some of the tailwinds or supply chain’s heel, as Monish talked about. We're taking actions ourselves, and we're looking at what additional actions we can take there. And we're looking deeper in the company as well as we work to prepare for the healthcare spend, we've been looking at 3M ParentCo as well. And how do we simplify, streamline and put our position ourselves closer to customers. So it's really looking deeper and broader. And I think taking actions, proactively taking actions against the outlook we have for our markets. Mike or Monish, you mentioned that industrial end markets are moderating, customers are cautious. I think for instance, you mentioned industrial adhesives and tapes down in Q4. Has there been a material change from conversations that you've had previously with industrial customers, or is this just gradual moderation? And then is the regional weakness that you're seeing in China just a function of COVID interruption and more consumer base versus end demand related? And how do you think that pans out in 2023? Yeah. Andy, back to Monish's comments, we're seeing kind of mixed performance in the industrial markets. We see strengths as we said, as we came through the quarter in areas like electrical markets and automotive aftermarket. We were seeing some moderation in specific end market segments. And the comment about industrial adhesives and tapes and closure and masking is some of that is related to the electronics slowdown. So that's part of that impact. It's also impacted by China. So China has really got a couple of things that are part of the slowdown. One of them is COVID and the interruption in the markets in industrial production and GDP. It's also reflecting the importance of electronics to that market into our business there in China. And we see that continuing those dynamics that we saw in Q4 continuing into the start of the New Year. We saw some moderation in specific segments of industrial. We saw specialty vehicle construction markets. We saw some moderation coming through the end of the quarter. We're off to a slow start as we start the year. There's a couple of areas of destocking really related to those end market segments where we've seen nothing more broad-based than that. We had strong performance across some of those other end markets in industrial. But – we're starting to see some moderating and, like I said, January is off to a slower start for industrial. Mike, that's helpful. And then maybe could you give us a little more color regarding price versus cost expectations for 2023. You mentioned the low single-digit price improvement you're seeing. You also mentioned supply chains are healing. Are you generally seeing pricing hold up for you despite some of this demand weakness across the portfolio? And then versus raw material and energy related headwinds, does that price versus cost equationgetting increasingly green as you go throughout the year? Yeah. So I think two different points in there, Andy. As you correctly pointed out, the carryover impact on what we have assumed right now in the guide is two pieces on the selling price. We said approximately 2% -- at the same time, the carryover impact of both raw materials and energy inflation is approximately $150 million to $250 million. So when you just do that equation together, right now, it's positive. I think what we'll see as we go through is how do supply chains heal and how fast can we get the cost out. But at the same time, it will take a little bit of time as we sell through our higher cost goods to our inventory, you're going to see some of that moderate, but it will start showing up as the year progresses. The key question for us that we have to think through and that's what we are thinking through is, as deflation starts showing up in the economy, the discussion that's going to come up is the elasticity of price across not just our company but across all companies. And what we have found over time, Andy, as you know, 3M so well that our innovation ultimately drives the value that we add for our customers. And historically, we have been able to have a good price cost equation, because of the value that we add for customers. So, seeing what we'll see in 2023 will depend on supply chains and what plays out in the long run, we are very confident that the price/cost equation continues to be green just because of the value we add to our customers. Just few questions. What are you guys just -- and if I missed it, I apologize, but are you sort of modeling an explicit recession in your forecast? What are your macroeconomic assumptions? I know you sort of said things are slowing, but are you explicitly modeling a recession? Yes, Andrew, underlying our view of the year is -- the projection for the macro is part of it. And then we're talking about specific markets and dynamics that we're seeing coming through the quarter into -- coming through the fourth quarter into the New Year. So when you look at the macro global GDP, IPI in the 1.5% kind of range is the outlook for the year, you can see US softer than that, you see GDP below 1%, you see IPI even projected to turn negative as we get into the middle of the year. So those are kind of the macro dynamics that we're looking at. We're also looking closely as we talked about in a couple of these market segments. Fourth quarter, you saw this 10% to 30% decline in the consumer electronics build and that is expected and projected I would say, to continue as we get into first quarter and the first half of the year and consumer discretionary spending and the impact on the -- our end markets is -- that was in decline in Q4, I expect that to continue. So the macro is part of it, and we're looking closely at these key market segments and the indicators there. And I think it really says Q1 looks like Q4 and there are some areas of additional slowing. And then we kind of look at the total macro for the rest of the year as we shape up our outlook. Got you. And then the question about pricing. Just historically, given -- and I know the way you report pricing is not necessarily how we think about pricing internally. I completely appreciate that. But has anything changed in the market structure in terms of your ability to drive the pricing. I just would have thought for 3M reported pricing would have been more of a tailwind into 2023. But it is what it is, but are there any structural changes that you're seeing and that you're trying to address? Thank you. Andy, there really is two parts to our pricing actions in the near term. One of them is what Monish talked about, we are always really looking closely at our price value in the marketplace. Our innovation delivers value to our customers. We manage our pricing in the -- take advantage of that value and really make sure that we are getting that value through our broader market pricing. The last couple of years has brought in the inflation dynamic, and that's really been the driver. We are taking pricing actions to adjust for the input cost. And so you've got a mix of our innovation as well as the inflation dynamic. And so as you look into 2023, you're -- we're confident we'll continue to position ourselves in strong price value based on our innovation we are going to be managing inflation along with everyone else, how do we see that progressing, and what will we do with our prices, adjusting those if we see additional inflation and managing those as the -- I would say the elasticity in the market around inflation plays itself out. What are you guys seeing on the inventory side of the -- of your more industrial businesses? I think you talked a bit about auto, but maybe just on the general industrial side, customer inventory behavior? Yes. Steve, I touched on a little bit of that. I would say as we began Q4, overall inventory looked to be in pretty good shape. And that was with the notable exception of Consumer. Everyone was working to reduce the inventory, and we saw a lot of destocking efforts in consumer. As I said, we're starting to see some destocking in industrial. I would say, Asia and China, where we are seeing weaknesses in consumer electronics driving some of that. And as I mentioned earlier, some specialty markets like construction and a few other areas like even packaging, we're seeing some reduction of inventory as we start the New Year. When you look at our transportation and electronics business, the consumer electronics OEMs are reducing inventories. With that outlook for their demand, they're reacting to it. Automotive OEM inventory still remains low. It's improving, but it remains low as they're recovering from some of the supply chain disruptions. Health care, overall, looks pretty stable. We see oral care channel reacting to some of the consumer discretionary spending and slowing there in oral care that we saw really in the second half. And then it comes back, the biggest move is in the consumer where our retailers are still aggressively reducing inventory. So some dynamics reflecting some of the changes in demand in the end markets. Okay. And then you mentioned January was starting slow. I mean, can you give us a little bit of context? Is that -- is January an organic kind of like below the low end of the annual range? Just roughly, just some color on kind of how slow January started for you guys? Yes, Steve. So back to January, yes, it is lower than the overall range. And partly, that's also driven by the toughest comps that we're going to have going into 1Q. As I mentioned, 7.2% to 7.6% -- $7.2 billion to $7.6 billion is the revenue range. It will be down 10% to 15% versus last year's adjusted. And you have to take revenue and adjusted for the exit of PFAS manufacturing, which would be around $8.5 billion. But embedded in that is 3% to 4% from foreign currency headwinds. So it's a Q4 carryover impact. You've got 1% from divestitures, which is based on the closure of the Food Safety and some of the other transactions we did in 3Q. And then you've got a very large headwind from DR and Russia. If you recall last year, we had a very strong 1Q with the Omicron variant. Plus at that time, we had not announced the exit of Russia until mid-March. So that's another 300 to 400 basis points of pressure because you've got a comp. And therefore, overall, it's LSD to MSD is what we think right now is organic sales growth for 1Q. And what you'll find is as the year goes on, these comps start getting easier and that will start showing the growth on a year-over-year basis. Hopefully that answers your question? I know we've talked a lot about the organic growth guidance for the year. I guess I'm just curious, when you think about the consumer specifically, it seems like you're embedding improvement as the year goes along. Is that just a function of inventories getting better? How much of that is China reopening? I just want to get an understanding of that business specifically. Yes. So, on Consumer -- so you're right, Joe, I'll start with the summary, which is we are expecting that as things stabilize and as customers slow down their destocking, you will start seeing the comps get better in the year. The fourth quarter was extremely hard. And as Mike said, we saw an acceleration of a trend in December. We continue to see that in January, and that's why the first quarter starts pretty soft. But our hope is that as things stabilize, as destocking gets better, as consumer confidence builds into the year, we'll start seeing the consumer business starting to get better. Got it. That's helpful, Monish. And maybe my follow-up question is a little bit of a longer term question on the electronics business. So, specifically, I think in your comments, as you mentioned that the shift into OLED. I know there was an announcement about Apple making your own custom displays starting in 2024. Just trying to understand like how that will potentially impact your business beyond this year? And then is it already expected to impact your business in 2023? What -- I would answer and then I'll ask Mike to join in. The way I look at this, Joe, is there are a couple of things. The company has always -- has been looking at the LCD-OLED transition for a period of time. And that transition has been happening for a few years and the team has continued to deal with that as it goes on. What the team is working through is as new devices are coming on, what does that mean from a OLED to LCD ratio to mix. It definitely did have an impact for us in 2022. And then we are seeing what trends we are seeing -- as of right now, the trends we saw, we have predicted into 2023. But with that said, the one thing about the Electronics segment and especially the display teams is they always have a lot of innovation that is out there that helps offset some of these headwinds that come across. That business keeps reinventing itself as time has gone. For example, Ashish and his team have launched products that are used in AR and VR technology, which also hopefully is a growth market in the future, and that's what -- that business is very good at looking at these trends, working these headwinds, and then finding innovation to offset that as time goes. But right now, we have embedded what we think is the trend in LCD-OLED shift into our 2023 guide. Yes. And Joe, I would add we've been managing that transition and that trend for some time. It's -- and it's part of our innovation that we're doing with our customers, too, innovating on both sides of that, the OLED displays. And as Monish said, the other higher growth segments in electronics, historically, our electronics business has been overweight to consumer electronics. And as we've talked about over the last few years, our strategy is continue to innovate there, and we're working with our customers multiple generations ahead, whether it's OLED displays or other applications, we're really working with them to innovate and drive value and opportunity for 3M in that consumer electronics. At the same time, we recognize the big growth drivers are some of these other higher growth segments. And Monish talked about AR, VR now emerging as one of those opportunities. Automotive electrification, of course, is the largest of those right now. There's other areas like factory automation, and even into electronic, into semiconductor manufacturing kinds of processes. So we are innovating in those spaces and at the same time, looking ahead and managing through the next display technologies and the next mobile device technologies and consumer electronics. Good morning. Maybe just wanted to start on the operating margins. So, sort of, backing into what you've talked about, are we right in assuming that the guide embeds sort of 19% operating margin for the year and sort of mid-teens in Q1? And then, on that Q1 aspect, very heavy decremental margins sequentially, even without the restructuring charge. Is there a lot of sort of under production going on at 3M to clear out inventory, for example? Just trying to understand why that Q1 margin is so light. I think, it's like a 50% decremental or something excluding the restructuring. Yes. So as I've always said, Julian, first is, volume gives us the best leverage. And what you have seen in Q4 continues into Q1. As we have said in Q4, we took some aggressive actions on making sure we rightsized our manufacturing facilities to help control inventory. Our plan is we will continue to aggressively manage production as a way to -- manage production as a way to manage cash at the same time. So we're not building unnecessary inventory. So that's number one. I think number two is, as I mentioned, there's continued pressure on a year-over-year basis on foreign currency between 3% to 4%. If you look at it versus fourth quarter exit rate, it's pretty much, I would say, flat to what fourth quarter exit rate was. And then the other item, you mentioned the restructuring, but we also have other normal 1Q items that we have from an accounting basis that we take, which is normal in every quarter. And that's why the start to 1Q is slower. But as you accelerate or move through the year, volume and the supply chain healing are the two factors that will continue to drive us to get these margins better. And if we're looking at it on a year-over-year basis, it's all driven by the comps that we had last year, which impact us heavily. So its lower volume in Q1, that's a big driver and volume will be the big determinant on what we think Q1 is going to be. And, Monish, is that roughly right on that sort of mid-teens operating margin Q1 and 19-ish for the year in your guide? Okay. Thanks a lot. And then one quick follow-up on that for Mike. Mike, you've announced a restructuring program today. I think it's the first kind of formal discrete one since fourth quarter of 2020. And you had the business transformation savings program prior to that. Just wondered, sort of, when you think about the scope of the current restructuring plan, what kind of savings run rate we should expect annually when do you get to that? And how do you assess the scope of this being enough to get margins back on track as you had those prior restructuring programs, but margins have stayed under pressure? Thank you. Yeah, Julian, the way we're thinking about it. And like I said, this is certainly taking on what we see in the markets and in our performance and the supply chain dynamics that we're facing, all of that's part of what we're focused on as we look at these actions as we go through the year, adding to what we've already announced. And then we are thinking and getting ready for the spin off healthcare. We're taking a deeper look, as I said, at everything we do. There's opportunities to streamline what we do as a company in the face of those end market dynamics and our operations. And we're learning from the changes that we've made to this point. So we'll continue to work on that. In terms of giving you a view of the impact of that, that's something we'll come back with as we make decisions and announce those actions, those additional actions as we go through there. And also for providing first quarter guidance, I know that's not a typical practice but given all the moving parts, we appreciate that. So my question relates -- it's come up a couple of times on the healthcare spin. Can you remind us the timing that you're expecting? There was some noise about the potential challenges in the courts. Where does that stand? And on the separation costs, how much is this impacting 2023, or is that all excluded and stranded costs? How quickly would you be able to address those? Thank you. Yeah, Deane, maybe I'll talk a little bit about just the spin. Monish, can talk about the separation cost model. We have a dedicated team working and building the execution plans. We're making very good progress. We talked about our expectation that we would be completing the spin by the end of 2023, early 2024 and that's the focus for the teams as they work to execute this. You commented on there had been some -- actually, there was a suit in the marketplace around the spin of healthcare and would we be able to complete that. And that was something that was dismissed. And so there's nothing from that dynamic that's impacting us. It's really about our teams working to execute the spin. And as I said, they're making very good progress. We're confident that we're moving in the right direction and moving ahead at pace. So as regards to the guide, Deane, as we had disclosed when we announced the spin off healthcare, we currently do not be -- we are thinking of counting it as a special item, so that will be excluded from our ongoing operations. We are unable to predict how much of that will show up in 2023, so we haven't put that in our guide. But when we announced the transaction, we had given you a framework that our transaction cost of spin-off will be somewhere in the range of $1 billion to $1.5 billion, which is a mixture of CapEx and OpEx. The teams are continuing to work that as they go through right now. We've now been at this for the last four to five months. So as we get better estimates around that, we will definitely keep you posted. And then as regards stranded cost, as Mike mentioned, and we had also mentioned it in the last quarter, this is an opportunity for us to look at everything that we do as we are getting ready for the spin. And our goal is to reduce stranded costs as much as we can, and we'll keep working it as we go through it. And we'll definitely let you all know as we figure this out. But the teams are actively working. The teams are staffed and they're doing an amazing job keeping the program on track. Thanks. Good morning, everyone. We've covered a lot of ground here. But I want to go back to 1Q 2023, perhaps Monish. We calculate a 15% margin, which is kind of similar to Julian's mid-teens. I don't think we've ever seen a margin that low. I think the GFC, we saw 17% and change margin. So just wondering why margins will be so low. And I understand supply chain is a factor here, but why 15%? What's going on? And as part of this sort of question, the kind of the coverage of the full year plan even at the low end of the range is still really, really low. So I think it's about 17% to 19% coverage, making a very big back-end loaded year. So I know you said volume gets better, but what gives you confidence and what can give investors confidence enough capture in the back half of the year? Yes. So I think two different questions and both great ones. So I'll try to answer the first one, similar to what I told Julian. Volume gives us the best leverage. And when you just look at it even sequentially and you adjust for FX, which helped us versus a guide that we had given volumes are going to be flat. We have started very low in the month of January, and that puts tremendous pressure on our fixed cost, number one. Number two, we have a restructuring charge. And then number three, our tax rate is 19%. And then, of course, we have another normal 1Q items from an accounting basis that we take. So when you put all that together, I would say, Nigel, it comes down to volume. Volume is down 10% to 15% on a year-over-year basis. And so that's number one. This is the toughest comp and you have DR and the exit of Russia, both of which we have disclosed in the past. When you apply them at company margin, which is at 46%, that puts pressure also on a year-over-year basis. When I go through the remaining quarter year and as you correctly asked the question, what happens on margins, as you start thinking about we exit some of these comps that are difficult, 1Q being the toughest, volumes will start, our comps will start getting better. The supply chain efficiencies, the actions that we have announced also in 1Q and some of the actions we took in 4Q will all start showing up in the remaining of the year. Again, as I mentioned, some of these items, including cost out from raw materials take a little bit of time as we work through our higher cost of inventory through the system. If you also look at external data, and that's what we can look at because none of us are able to predict what we can in the future, external data says the second half gets better. It gets better in China, it gets better globally. And that's another reason why we are hopeful that as volumes come back in the second half, we should see our own margins go up and our own revenue go up. But with that said, at the end of the day, we control -- we don't control the markets, but what we definitely control is our own actions. And so continuing to drive supply chain efficiency, continuing to make sure that we are being as nimble and agile as we can. Using Mike's words, we are looking at everything. We're being very careful and discretionary in hiring. And 2023 is an important year for year. It's a year that we plan to execute on a lot of our strategies over the last few years, including the spin of our health care and improving our supply chain operations. I just want to end with your question, we are not satisfied with where we are. We're going to continue to look at this. We're going to continue to be nimble and agile as the volume plays itself out. And our goal is to keep building from where we are right now. Hey, Nigel, I just want to correct one thing Monish said. Our total sales for Q1 are going to be down 10% to 15%, not volume. Okay. I was going to follow-up on that. Thanks for that clarification. Bruce. And I know, I've asked a few questions there, but I do have one for Mike. You said, everything on the table in terms of your reorganization and things about new ways of doing things, five or six years ago, 3M went through a sort of pretty big centralization of supply chain and business support functions. In hindsight, has that left the organization a bit too rigid? Was that the right move? And could you unwind that stabilization? Yeah, I would say that, Nigel that, the change is that – there's a couple of different changes that we made to the supply chain maybe that you're thinking about. One was we did take actions on some of the structure and really looking at factories, our footprint of factories a number of years ago. And then we moved to – when we announced the change to our business group led model, we went to a common supply chain model globally. And we made some additional steps in that in last year, really to continue to drive more flexibility, greater streamlined performance end-to-end in our supply chain. So, we see it really more as an opportunity to build on the changes we have made and drive simplification, streamline, more productivity, reducing our costs, delivering more directly to customers. So it's continuing to build on some of those changes. I think those actually have positioned us to be more flexible as we go ahead. And there's an expectation that supply chains will continue to heal. So we want to be able to take advantage of those of those tailwinds that we hope to see as we go through the year. At the same time, we control what we control, and that is making additional changes based on what we've learned to, to really execute our performance in our supply chain. It's the biggest opportunity we have to improve margin and cash flow as we go through the year. Hi. This is Dan Rizzo on for Laurence. Thanks. Thanks for fitting me in. I don't know, if I missed this or not, but you mentioned that free cash flow conversion is 90% to 100% this year. Is that long-term goal? Can you maintain that? I mean, as things kind of, I guess, will get less volatile in the out years? For last year, we ended at 82%. As I've said multiple times, the opportunity for 3M's cash from a working capital comes from inventory management and EP. And to answer your question, is it sustainable, of course, it will ultimately depend on the income that we generated depends on how supply chains behave and the capital. But if you just look at the ability for us to use data and data analytics to help drive inventory and working capital clearly exists. In the fourth quarter, the teams did an amazing job to take inventories down, got it down by nearly $250 million. And as supply chains start to heal, this is clearly an opportunity for us, and we're going to keep driving that. To wrap up, we are focused on creating value for customers and shareholders in a challenging environment. We will continue to take actions to improve our performance, control costs and drive simplification while building 3M for the future. Thank you for joining us. Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation, and we ask that you please disconnect your lines.
EarningCall_1461
Good day, and welcome to the Lakeland Industries Fiscal 2023 Third Quarter Financial Results Conference Call. All lines have been placed on a listen-only mode, and the floor will be opened for your questions and comments following the presentation. During today's call, we may make statements relating to our goals and objectives for future operations, financial and business trends, business prospects and management's expectations for future performance that constitute forward-looking statements under federal securities laws. Any such forward-looking statements reflect management's expectations based upon currently available information and are not guarantees of future performance and involve certain risks and uncertainties that are more fully described in our SEC filings. Our actual results, performance or achievements may differ materially from those expressed in or implied by such forward-looking statements. We undertake no obligation to update or revise any forward-looking statements to reflect events or developments after the date of this call. During today's call, we will discuss financial measures derived from our financial statements that are not determined in accordance with U.S. GAAP, including EBITDA and adjusted EBITDA. Reconciliation of each of the non-GAAP measures discussed on this call to the most directly comparable GAAP measure is presented in our earnings release. At this time, I would like to introduce you to your host for this call, Lakeland Industries' Chief Executive Officer, Charlie Roberson. Mr. Roberson, the floor is yours. Thank you, John. Good afternoon, and thank you all for joining. I'm joined today by Lakeland's Chief Operating and Financial Officer, Allen Dillard. As you saw in this afternoon's press release, Lakeland delivered another quarter of sequential improvement, with net sales of $28.4 million and a gross margin of 43.3%. Our sequential revenue growth was primarily volume driven, and our gross margin continues to exceed our long-term target threshold of 40%. While we're proud of the sustained profitability we've delivered, macroeconomic headwinds have continued to hold back our revenue growth potential in fiscal 2023, as global industrial markets remain pressured, a continuation of demand trends we have seen year-to-date. This is particularly true in our European and Asian markets as rising inflation and energy costs, along with zero tolerance COVID policies, respectively, weigh heavily on industrial markets in these regions. While we anticipate these conditions will continue through the first half of next year, we believe that the industrial decline in these regions will be somewhat mitigated by a transference of some industrial activity to other geographic regions, specifically India. India recognizes the opportunity it has to replace China as manufacturer to the world and is aggressively working to attract manufacturing from China. We are responding by increasing our sales presence in India and leveraging our India manufacturing with the goal of accelerating our growth there. Despite these ongoing global market complexities and industrial headwinds, our team has been successful in accelerating the initiatives we have in place to stabilize or enhance our operating model. Allen will touch on this in more detail, but I would note that these efforts cut across our organization and include manufacturing and cost structure rationalizations, as well as targeted resource allocation between our human and technical assets. These efforts continue to flow through our bottom-line results, and we remain focused on positioning Lakeland for continued growth regardless of broader economic conditions. As I indicated last quarter about our results for that period and which I reiterate today about our performance this quarter, we remain proud of our near-term results and the foundational changes we are putting in place to ensure success in achieving our long-term strategic goals. However, we're not satisfied with our results in the short term. Though we recognize it's mostly macroeconomic related headwinds that are holding back our revenue growth in the short term, and note importantly, that we continue to outperform the overall industry in terms of growth, we must continue to adapt and react to the near-term environment while remaining focused on achieving our long-term targets. For the past several quarters, we've invested in maintaining a high level of in-process and finished goods inventory to enable us to serve our customers across the globe, focusing on quality, reliability and customer responsiveness. This overall strategy remains unchanged, but with demand in certain overseas markets coming in weaker than originally anticipated, we will look to proactively, but selectively, accelerate the reduction of our overall inventory levels over the next few quarters to better align these with current end market demand levels and to free up capital for additional investments in our growth strategy. Allen in his prepared remarks will provide a little more detail on the strategy in a few minutes. Turning back to our long-term growth strategy. Last quarter, we emphasized the importance of continuing and accelerating our shift to fire high-performance and critical environment product lines, which present the greatest opportunity for long-term sales growth and margin potential, while at the same time reducing the overall cyclicality of our results and achieving our long-term performance targets. In that regard, I'd like to spend a few minutes discussing the acquisition we announced earlier this week subsequent to quarter's end. This represents an important step in positioning Lakeland to execute this strategy more effectively. We announced the acquisition of Eagle Technical Products, a U.K.-based provider of fireman's turnout gear and flame-resistant arc flash protective garments to global markets. The addition of Eagle to Lakeland's platform is an important step in our pursuit of sustainable, above-market growth with high overall margin profile. This acquisition expands our global reach and enhances our product offering, particularly as it relates to firefighting applications outside of the North American market. Historically speaking, Eagle's revenue has been a mixture of European, Middle East and Asian sales. Looking ahead, this geographic mixture will stay the same in terms of regions served, but Eagles and now Lakeland's Middle East presence beginning in calendar year 2023 is expected to increase significantly as a result of a number of new important contract wins across this region that are expected to drive significant revenue growth for Eagle going forward. This growth is driven by important new contract wins for Eagle's core products, which are CE certified firefighting gear and industrial FR garments. We believe, as does Eagle's management team, that these recent important wins set the stage going forward for further growth in sales for these products in the Middle East as well as parts of Asia and Africa. From a manufacturing standpoint, Eagle has developed relationships with several quality contract manufacturers, and in the near term, Lakeland intends to continue to utilize this strategy. Eagle currently has a healthy order backlog and sales funnel, and its supply chain is well positioned to meet current and anticipated future growth potential. With that said, Lakeland does have in place a strategic and flexible global manufacturing footprint, and over time, we could shift some portion of this production to our owned facilities. From a design standpoint, Eagle has an in-house team of specialists, focused exclusively on European CE certified products, and we believe that will -- that their expertise can be brought to bear on other Lakeland offerings to increase sales opportunities in geographic markets not currently serviced by Eagle. In short, the acquisition of Eagle fills gaps in our international, high-value product offering, our geographic markets served, and in-product development skill sets. We are excited about the additional revenue growth potential that could emerge over time as we integrate our product design and sales teams, but importantly, we have not assumed any benefit from this in our models as of this time. We acquired the business for approximately $10.8 million in an all-cash transaction, and we fully expect the business to be accretive to Lakeland's top and bottom-line results beginning in early fiscal 2024. Eagle has a high degree of free cash flow generation, a diverse customer base, many of which are on multiyear contracts, and innovative proprietary product designs. As I mentioned earlier, our goal is to expand into higher-growth, higher-margin markets, and this is a crucial step that will accelerate that journey. I'm excited to see our team execute on this opportunity, and we look forward to sharing more about the integration of the Eagle business onto the Lakeland platform in the future. I'd like to welcome the Eagle team to Lakeland, and we're very excited to have you as part of our team and the potential for the future. I also want to thank my team here at Lakeland for all of their work recently in closing this deal. Lakeland was pleased to deliver another quarter of sequential revenue growth and strong profitability as our performance in the post-pandemic era continues to benefit from our strong product portfolio, end market and geographic diversity, financial strength and a continued focus on operational efficiency. On a consolidated basis for the third quarter of fiscal 2023, net sales were $28.4 million, domestic sales were $14 million, or 49% of total revenues, and international sales were $14.4 million, or 51% of total revenues. This compares with domestic sales of $11.9 million, or 42% of the total, and international sales of $16.3 million, or 58% of the total, in the second quarter of fiscal 2023, while fiscal 2022 third quarter domestic sales were $10.6 million, or 35% of total revenues, and international sales were $19.4 million, or 65% of total revenues. Similar to last quarter, European and Latin American industrial markets are still challenged, which has accelerated the geographic shift in our revenue towards the U.S. On a consolidated basis, compared to fiscal 2022, currency fluctuations negatively impacted revenues by approximately $1.6 million. In terms of product mix for the quarter, disposables represented 50% of total revenues for the period compared to 60% in the year-ago quarter. As we discussed last quarter, this is a result of our strategy to more aggressively shift our product mix towards higher value, higher margin and less commoditized, non-disposable products in specific markets. Gross profit as a percentage of net sales was 43.3% for the fiscal 2023 third quarter as compared with 41.3% for the fiscal 2023 second quarter, and 42.5% a year ago. During the quarter, our gross margin benefited from improved product mix and pricing power, lowering freight rates, and an increase in direct container sales. Lakeland reported operating profit of $2.2 million in Q3 2023 as compared to $1.8 million in Q2 2023 and $4.2 million in the third quarter of last year. As a result, operating margins were 7.8% in the third quarter, up from 6.4% for Q2 2023, down from 14.1% for the third quarter of last year. Operating income was negatively impacted by currency fluctuations, primarily related to the Chinese Yuan, which totaled approximately $800,000. Operating expenses also increased due to increased sales expenses of $400,000 admin -- and admin expenses of $400,000. Operating expenses also included $200,000 of severance associated with staffing adjustments. Lakeland delivered net income of $1.4 million or $0.19 per basic and diluted share during the quarter. This compares to a $900,000 loss or $0.11 loss per basic share and diluted share for Q2 2023 and $2.9 million profit or $0.37 per basic and $0.36 per diluted share in the prior-year period. EBITDA for the fiscal 2023 third quarter was $2.6 million compared with $2.1 million for the fiscal 2023 second quarter and $4.7 million for the prior-year period. Adjusted EBITDA for the fiscal 2023 third quarter was $3 million compared with $2.5 million for the fiscal 2023 second quarter and $5.1 million in the prior-year period. Adjusted EBITDA margin for the quarter was 10.4% as compared to 9% last quarter and 16.9% in the third quarter last year. Capital expenditures for the three and nine months ended October 31, 2022, were $500,000 and $1 million, respectively. Year-to-date, our capital expenditures principally relate to purchases for expansion of our manufacturing facilities in Mexico, Vietnam and India, and a continued enhancement of our global IT infrastructure. We expect CapEx to be approximately $2 million for the full fiscal year as we continue to make these investments. Moving to the balance sheet, Lakeland ended the quarter with cash and cash equivalents of approximately $34.9 million. The company continued to have no debt at the end of the quarter, and has up to $25 million available from bank credit facilities. During the fiscal 2023 third quarter, the company repurchased approximately $2.3 million or just over 194,000 shares of common stock under its repurchase program. This leaves approximately $400,000 remaining under the existing authorization. Subsequent to quarter's end, Lakeland's Board of Directors authorized an increase in the overall capacity of the share repurchase program, approving an additional $5 million for this program going forward. This new program will become effective upon exhaustion of the current program and, again, exemplifies our confidence in the company's growth potential and showcases our commitment to optimizing shareholder value. As it relates to broader industry inventory levels, stock levels are decreasing, albeit at a slower pace than we expected earlier this year. Given the slower-than-expected normalization of channel inventory, global inventory levels remain in an elevated state. In terms of Lakeland's inventory level, our stock levels remained flat quarter-over-quarter, and we have begun to proactively reduce these levels heading into fiscal 2024. Not only will this better align our inventory levels with current demand levels and free up capital for additional growth investments, as Charlie alluded to, but this strategy is a reflection of our commitment to shifting into higher-growth products and markets, as a significant portion of this inventory is made up of disposables. While certain pricing levers may be used to reduce disposable inventory levels, these efforts will be highly targeted and recoverable. We remain confident that given current market conditions, we will be able to orderly implement this plan and still be able to maintain our gross profit margins at or above our consolidated global target of 40%. Now, I'd like to provide an update on the progress made on our key strategic initiatives as it relates to our global manufacturing operations. During the second quarter, we continued the build-out of our new facility in Monterrey, Mexico. This facility will incorporate modern manufacturing processes and automations that do not exist in our current facilities. It will also focus on the high-value strategic products in our portfolio. This facility should be operational in our mid-fiscal year '24. Also, in this quarter, we continued to build out our cleanroom capabilities in Vietnam and initiated a realignment plan in our China facility. Additionally, as a part of our strategic initiatives, and as Charlie already discussed, we were pleased to announce the acquisition of Eagle Technical Products this week. Operationally, Eagle currently utilizes contract manufacturers to source their proprietary products and utilizes a highly leveraged back office to support sales and administration. Their EBITDA margin is a significant enhancement to current overall EBITDA margins for Lakeland and is aligned with our stated three to five year aspirations for Lakeland. As we look to the future, we are developing a migration path to utilize our existing manufacturing capabilities to service this business, which will provide opportunities for margin enhancement and increased profitability. Hey, guys. Thanks very much for taking my question. It sounds like you're positioning for quite an opportunity over the next couple of years in India. I was wondering if you can give us an update on how big your business is in India currently, and what the next couple of years could be, and if there could be an opportunity for perhaps growth in India to offset some of the macro-related weakness that you're seeing over the next couple of quarters? Hey, Alex. This is Allen. I'll start off with kind of the size and then I'll let Charlie jump into the market. So, currently, India is kind of a mid-sized facility for us. We have just under 100 employees in the manufacturing operations there, and it serves the European market and the American markets in addition to the India domestic market. And so, where we see the growth primarily in the near term is in the India domestic market. And as we bring the Eagle portfolio to the table, we see an opportunity to enhance our operations there. Yes, Alex, the current size of India is relatively small percentage of Lakeland's total revenue, and that's largely because of bureaucracy and some conflict as far as which products they want to utilize. It's a developing country. The use of disposables is a difficult sell there, all right. We do believe that with the acquisition of Eagle and their new product lines, we'll have a CE and NFPA fire service gear to sell there. The state, meaning their airports and state firefighting, prefer NFPA gear. Industrially, CE gear is preferred because it's lighter weight and about 30% less expensive than NFPA gear. So, we think the acquisition there is going to help us. I would also add that half of our manufacturing there is in a special economic zone to facilitate the import of foreign raw materials economically. Okay, that's really helpful. And then thinking about the Eagle deal here, I mean this is the first real meaningful acquisition, and as long as I can recall, it seems like you have a nice balance sheet to do continued M&A if you wanted to. Are there other good targets out there that you're looking at that could be bolted on here during this downturn? Yes, we're aware of the opportunities that the economic conditions may present. We are focused right now on a balanced approach to our use of capital. I won't rule out M&A, but it's not a priority over any other options. As we pulled more cash out of inventory, our situation changes, and that's going to be largely opportunity driven. Thank you all for joining us in today's call. We look forward to closing out a strong year for the company and preparing for growth in calendar year 2023 and beyond. Thank you, and have a good day. Thank you, ladies and gentlemen. This does conclude today's conference call. You may disconnect your phone lines at this time, and have a wonderful day. Thank you for your participation.
EarningCall_1462
Well, good afternoon. And for those joining via the audio stream welcome back to Citi’s 2023 Communications, Media -- Communication, Media and Entertainment Conference. For those of you who I haven't met, I'm Mike Rollins, I cover Communication Services and Infrastructure for Citi. Before we get started, I'd like to mention that we do have disclosures available at the registration desk and on the Citi Velocity page from which you're streaming the audio. We will work to incorporate your questions into today's discussion. So for those of us around the room, you have microphones and if you push the button, the light will go on and we'll get to your question. If you are streaming this connection, there is a question box on the page that you're on, and you can just submit your questions at any point and we're going to continue the tradition of using live surveys during our time together. They are completely anonymous. We're just collecting responses and it could be accessed with the QR codes, any information that are on the placards here on the table as well as they'll come up on the live streaming screen and you can enter in your responses. So with all of those details out of the way, I would like to welcome back Dan Schlanger, CFO of Crown Castle. Dan, it’s great to see you. Thanks for being here. So we like to start the year in the same way. I think, just thinking about your strategic and operating priorities as you look out to 2023, and as you look out to the coming year, are there any notable changes from what your priorities were over the past year? The answer to the second question is, not really. We have a pretty consistent set of priorities. We want to lease-up the assets we already own and we want to build assets that we think we can lease-up overtime. We think that we've set ourselves up very well on both fronts that the data demand growth in the U.S. drives demand for our business. And whether that's our tower business, our small-cell business, as long as data demand is growing, we think we have a very good place in the world that we continue to drive lease-up on the existing assets that we have and have the ability to project out where we think additional assets will be valuable overtime in the network to allow for that future demand to be serviced with additional infrastructure. And because we have a very healthy demand growth, a healthy set of customers that are competing well on network quality and consumers that are upgrading phones and looking for a better wireless experience, we think that creates a very good mix of dynamics that allows for us to see good growth in our business, both in 2023 and beyond. We're going to insert our first survey question into here. Get this going, but we'll talk about a few things before we get back to this. So the first question for our audience is, what do you expect Crown's organic tower growth to be in 2023, excluding T-Mobile churn? Help remind per your prior guidance and actually, I think this came up this time a year ago where you pushed out that T-Mobile churn to 2025. So this is just an organic number without that. And the choices are less than or equal to 4%, 4% to 5%, 5% to 6%, 6% to 7% or over 7%. So we'll see as those responses come back in, encourage everyone -- We'll get to -- yes, very much so. And if you'd like to actually be a part of the survey -- Okay. We're going to come back to this in a moment. But just one question before we get there, which is, as you look at the portfolio of what you have, towers, small cells, fiber infrastructure, how do you view the synergies of these assets growing faster together versus if they were simply standalone portfolios or separate portfolios? We think we're -- the significant benefit for having everything under one place is that, we can have a conversation with our customers that's beyond a specific asset and more geared towards where they have a network issue that they need to address, and we can help them address it. So if they have a spot in their network that requires coverage, we don't just go to them and say, "Oh, yes, we own the tower, you can use ours if you want". We can talk to them about how do you best want to address that spot. And not only today, but five years from now or 10 years from now, and we can have a conversation that extends beyond selling a product and more towards selling a solution. I think if you think about that as your own personal way of going about the world, it's much better when somebody can help you solve a problem than it is somebody saying, "Hey, if you want this thing, you can own it". And we believe that develops a tighter relationships with our customers, so that we can have better back and forth, better communication and a better relationship. But it also allows us to have a better insight into where we think infrastructure will be needed. And you saw some of that with our conversations with DISH and the agreement that we signed with DISH a few years ago around their tower business primarily, but it included a fiber aspect to it. And the reason that was important was because DISH is trying to build an all-digital fiber-connected network of towers and other infrastructure assets. But they are very much in a go-as-fast-as-you-can type of mode, and they started from almost zero because they didn't have a lot of network experience to begin with. So they wanted the ability to go to one provider and get both towers and fiber at the same time so that they could have less to manage themselves. And just that in and of itself that they thought it was important to go to one provider and wanted fiber to be included in a predominantly tower MLA was an important validation of why we think having different capabilities together will help, because it allowed us to have the first-mover advantage with DISH, and we believe put us in a position of being able to generate more than our fair share of new leasing from DISH as they're building out the first days of their network. And those are all really important because as it goes around our company, but you can't get amendments on towers you don't have. So we wanted many towers with DISH as we can get so that as they grow their network and want to add more equipment, they're going to go to the places they already have equipment, and that's going to help our growth in the future. So not only does it help us in the near term that we get lots of growth, but we believe we set ourselves up for long-term growth. So again, back to our priorities, lease-up the assets you have and invest in assets that are going to lease up over time. Having fiber was an important aspect of getting both those new leases and the future lease-up that we will see over time. And that's the type of relationship that we believe is spawn by having a conglomeration of assets as opposed to just one thing that we can go sell, "Hey, if you want a pen, you want it to be blue". Thinking just a little bit more about DISH for a moment. When you announced that opportunity, I think there was a thought of time and the opportunity for Crown Castle to maybe take more than its fair share. How is that playing out in terms of the DISH opportunity? From what we can piece together from publicly available information, we believe we have taken more than our fair share. It seems like we have generated more growth out of DISH than what our competitors have been able to generate and we believe our agreement with DISH is a reason for that. Like I said, we're a first-mover. We also believe, as they have said that they wanted to anchor a lot of their locations around Crown Castle sites because we had that agreement in place. And it incentivized them to go on as many sites as they could on our system. We gave them access on up to 20,000 sites. And there's an incentive for them to go on a lot of those. We want them on a lot of them as well for all the reasons that I just articulated. And we believe that structure and their desire to utilize our asset base as their anchor of their build really has allowed us to take advantage of more than our fair share. I do also believe that the location of our assets has helped with that. We are skewed a little bit more to the urban areas than our peers are. But I think the majority of what we've gotten over our fair share would be because we move first with DISH, and we're able to make that agreement come to fruition. After you had that announcement, just to stick on this for just a couple of more minutes. After you had that announcement, I recall the next quarter you increased the amount of committed revenue that's in the backlog. And which, I think, established what you expected to be the minimum over the term of the agreement. Is a lot of that now in the revenue? Or is a lot of that still on the come in terms of the opportunities to monetize that relationship? Yes. That number, obviously, is the total amount of the revenue that we see over the course of the life of the contract, and that contract is 15 years. So a lot of that still is yet to come. But we have recognized revenue with DISH as they built out their network and gone on sites. And we've seen them be very active. We've been very impressed by the speed at which they were able to build as an organization to deploy a nationwide network. They have been a very fair and demanding customer. They have made us go as fast as we can and pushed us really hard, and we think that's good for everybody. And so, we've both recognized activity and there's a lot of activity yet to come. So I'll share the survey results, then we could talk a little bit more zooming out on just the broader organic growth opportunity for the domestic business. So 25% thought growth -- organic growth, domestic 2023, of course, all domestic for towers is less than or equal to 4%. 63% between 4% and 5% and 13% between 5% and 6%. It sound like you wanted to get in on the survey and share your answer. Well, we've given guidance, so I have an answer. What we've said that we think we're going to grow in 2023 is around 5%. So I'm interested in the split, whether people chose 4% to 5% or 5% to 6% based on if they thought it was 5%, which way did they go. But my guess is, most people would be centered around that 5% because generally, when we've given guidance, we're in the – they were in the ballpark, we have a pretty good sense for what the growth is going to be. What we're excited about though is, we have, over the course of the last few years, been a little higher than that. It's been 6% or so or a little bit more, and we've led our industry in the amount of growth in the U.S. tower market. We're excited that we're able to stay in our long -- what we think for the foreseeable future, we will grow about 5% to 6% at revenue for towers. And being in that range, we think is really indicative of what I started with that there's a good set of dynamics underlying our growth in the U.S. with lots of demand and growth in that demand, good competitive tension among our customers and lots of demand from our consumer -- from the consumer in the U.S. of wanting a better mobile experience. And all of that is pointing to us being able to sustain a 5% revenue growth over time. And our business is such that adding year-over-year of good growth generates really strong returns for our shareholders for a long period of time. And we're excited about where we are. We think we're still in the middle of an upgrade cycle that will continue for years to come as our customers continue to roll out more spectrum on towers and continue to compete with each other on network quality, those are all really positive dynamics for us. And when you think about that 5% to 6% longer-term annual opportunity, and you have agreements with a range of your large customers, how much visibility is there? Is it very high right now already because of the established agreements? Is there a certain amount of flex that's involved? How should we think about that visibility? We feel very good about that 5% to 6%, partly because we have the agreements in place with our customers. And those agreements, in essence, provide a level of growth that we know about, but it doesn't cap the amount of growth. There isn't like, okay, that's the most you could ever get. So we actually feel really good about that 5% to 6% over a period of time in the foreseeable future and the ability that if things go really well, we could do better. That's part of the way the tower business has been for a long time is -- I think you've heard me say this before. I think our investors, in many cases, overestimate the amount of growth we have in any one year and significantly underestimate the amount of growth we have over a decade, because people look out and say, oh, you can't grow that much over a long period of time. We're going to run out of voice minutes. They're going to -- everybody is going to have a phone and they're all going to call as many people they can. You're never going to need another tower again. And then you're going to run out of data minutes. And then it's going to be -- well, now it's unlimited so there's not going to be a huge amount of incentive to invest and continue to build the network. There was always a reason to believe that the demand growth was going to tail off. And we've never seen that in our business. We always see that we as consumers continue to consume more data. And that leads to significantly more growth over a longer period of time than most investors would think. And I think if we had gone back 10 years ago and said, do you think we would be at the level of revenue and amendment activity that we are in 2023? As we asked that question in 2013, everybody was said no way, as we hadn't even gone into really the 4G upgrade cycle that we've seen and now we're in 5G. I just think that the ability for our business to add 5% to 6% growth over and over and over again turns out to be a really good thing over 10 years and more. So the next survey question is going to preview where we're going, but we won't get there just yet. So the next question that I'm going to ask our audience to help with is, when will small cell bookings and installs accelerate? 2023, 2024, 2025 are difficult to estimate. So we'll see what they come back with. But while they're thinking about the answer, DISH is new colo for you. But for the other major carriers you have in the U.S., as they're finishing the mid-band builds, are you starting to see the pipeline and interest in colocation and densification increase or change? Yes. To us, it's really unimportant whether it's colocation versus an amendment, because what we get is incremental revenue on an asset that we already own. What we're seeing is a general consistent trend or a trend that is generally consistent with what has happened in the past in the tower business is, our customers when faced with the desire to deploy a lot of spectrum over large loss in an area, they start with amendments for the most part, because they know what is on the tower, what the propagation characteristics are, what the traffic patterns are and they already have the network set up to see where one tower overlaps with another, and so it goes faster and easier for them to go with amendments first. And then they move into colocations, which are putting assets on -- or putting antennas on assets we already own, but they are not on yet. That takes more network engineering, because it adds another point of presence, and they have to shift their network around a little bit, and it takes a little bit longer to figure those out and it's a little more expensive. So they go first amendment into colocations and that's kind of how they generally move through an upgrade cycle. And we're seeing much of the same thing now. I think that we've heard some of our customers publicly say good things of that nature, too. We kind of -- we've gotten a lot of C-band out, now we need to infill. That infill, in many cases, means adding in some places they don't already have covered with a new band, in this case, C-band. So yes, we're seeing that. That's a natural transition that we are seeing. And in terms of churn, churn recently has been running from what I recall at the lower end of the annual 1% to 2% ex kind of major consolidation churn. And given all the agreements in place and the visibility you have, again, keeping T-Mobile out of this equation, should it stay at the lower end now going forward, at this like one-ish percent type level? I think we'll be within 1% to 2%, but on the lower end of the 1% to 2%. Yes. I think there will always be certain years that something happens and it pops up. So I don't want to say it will always be at the one-ish percent, but 1% to 2% is a good range and the lower end is generally what we've seen when there hasn't been consolidation churn within the tower business. But like we've said, the -- you kind of excluded the T-Mobile churn, I want to just hit it for a second. What we've done is, we've signed an agreement with T-Mobile where the deconsolidation churn for the most part hits in 2025. So we consolidated what was churn across a long period of time and pushed it into 2025, and that's around $200 million of run rate revenue that will churn in 2025. And what we've said is, past that there will be some churn, but it will be within that 1% to 2% normal course for us. So like I said, I think that normally will be around the low end of 1%, but there might be some times when it might pop up a little bit depending on a specific year. Okay. Got it. And so as we are just closing out the discussion on the domestic business, are there -- there are certain things that are in these agreements already and there's probably things that are going to emerge in the future that may not be covered by the agreements and could be an opportunity for further monetization. Are there certain things that we should all just be thinking about and looking for whether it's -- I mean, just throw out a few things randomly like a massive [MIMO] (ph), taking antennas from three sectors to maybe six sectors in certain markets which could accommodate certain types of capacity for things, including like fixed wireless, things that -- are the -- those things or other things that you would imagine that we should just be aware of that could really be an interesting source of incremental monetization that's not covered by these base agreements. I wouldn't say that there's anything on a -- when you're talking about structural basis. But what I would say is, the compounding effect of data demand growing at 30% a year is hard to imagine when you sit today. What that means is, over the next two to three years, the incremental amount of data will be equal to the total amount of data that is moving over to the network right now. So 30% growth means every two to three you double. The ability to keep up with that is going to require amount of investment in additional antennas, additional tower sites, additional small cells. I think it's hard to think through how much that will be because the increments have been small over time, and now we're getting to a point where the network is actually really big, and we're still going to have to double. And how that gets done, the true architecture of that, I believe is less important to us than the fact that we as an industry need to figure out how to accommodate all of the consumer demand that is coming. And we believe at Crown Castle that we are best positioned to benefit from that demand because whether it is going from three sectors to six because we have fixed wireless or whether there's massive MIMO or whether it ultimately -- I know you didn't do this on purpose, but when it ultimately moves to small cells, we're somewhat agnostic as we benefit from it all. And our -- like I said, our MLAs don't have like a cap to them and say, well, forever and ever, this is the most we’ll ever make. It actually allows us to have -- if certain things are done, we can make more money. And I think that just the compounding effect of 30% demand growth year-over-year really result -- it gets back to the same thing I said earlier, really results in over a 10-year period, a lot more activity than what most people can think of when you start that 10-year period. So it's a good pivot into the small cell discussion. So we have the results of the survey back and 13%, 2023 when small cell bookings and installs can accelerate. 2024 is about quarter of the audience. And 2025 is about 38% and difficult to estimate was almost quarter of our audience as well. So as a dispersion, what are you seeing? Can you review for us with what you're seeing in the small cell business? You had some activity in 2022 and how the conversations may be evolving with these carriers, somewhat to what we're just talking about earlier, now that they're getting through this mid-band cycle and this amendment cycle, talk about the small cell opportunity. I would have bifurcated your question into bookings versus installs, because I think the difficulty is that, bookings to installs can take 18 to 36 months. And we've already seen the bookings acceleration. Over the course of the last 18 months, we have signed 50,000 additional small cell nodes, 15,000 with Verizon and 35,000 in T-Mobil. That was equal to about 70% of the total bookings we would have in the history of the company added together. That is an acceleration. So we believe that the bookings acceleration has occurred and now we're starting to get into the position where the installation acceleration is occurring starting in 2023, where we're doubling the number of nodes we believe will put on here from 5,000 in 2022 to 10,000 in 2023. We don't believe that we were capped there. We think that there's ability to grow past 2023 at 10,000 or more. So we believe we've already seen that acceleration in bookings and that 2023 is the start of the acceleration of installation, but we believe that we can accelerate even more beyond. And what that leaves us is a question, I think, that is underlying what your survey was, which is, when there's the next acceleration going to happen. And what I think that kind of ignores is that, the acceleration we're seeing today happened during the period that our customers, particularly Verizon and T-Mobile, were very busy deploying mid-band spectrum on towers. And even though they were very busy on towers, they knew that over the course of the next to three -- two to five 5 years, they needed small cells as the next leg of their network deployment and needed to get started on those small cells over the last 18 months to give us time to start citing them, building them and delivering them. And what's good about that is, like I said, even in the midst of being so focused on getting as many towers hit as possible with that mid-band spectrum, they knew small cells were coming. And there's no way that they gave us all of the small cell business that they're going to have over the next three to five years. That's not the way companies act. Nor do we think that they give us all of what they'll outsource. It's just the first tranche of what we think is a growth engine for us and the industry, because like I said, we -- as we look out and think through how much data demand is growing and how much network capacity has to grow to withstand that demand, that dynamic can't be -- serviced only with towers has to go to small cells, and that growth in small cells will drive significant growth in both additional bookings and installations and additional new build and co-locations for Crown Castle. And when we go back to our operational priorities of lease up the assets you have and build assets that will be leased up, that's exactly what we're seeing in the small cell business right now. The question of when we see that next round, we've already seen the first round of 50,000. When we see the next round, I think it's difficult to predict because we have a hard time predicting when our customers will prioritize specifically building out small cells over all the other things that they might have in terms of capital allocation priorities. We're ready, able and willing to provide the small cells as they come up. We have no internal capacity constraints that we have come across. We think we can ramp up more than 10,000 per year. And we think we can deliver more than 10,000 per year. So we will push as hard as we can to get as much on air as possible as quickly as we can and then get more bookings as quickly as we can as well, which will likely come from our customers looking out again three years out and saying, okay, what do we need in terms of network quality, in terms of coverage, in terms of capacity and our small cell is going to be a solution, and we believe the answer will be yes. And just a couple of clarifications. First is, the 10,000 for 2023. Remind us, is that exclusive of some of that episodic churn that is coming through the system? Yes. So it's exclusive of about 5,000 nodes of churn that is a result of the consolidation of T-Mobile and Sprint networks. So we think about on a net basis, we'll add 5,000 nodes in 2023, but that will be 10,000 additional nodes and 5,000 churn. The reason that we keep quoting the 10,000 as a doubling is, the churn, as you said, is episodic. It's because they can bind and they were on similar sites and they wanted to get rid of those. And going forward, the even realizing synergies, T-Mobile made a decision that they needed 35,000 additional small cells. So we want to talk about the overall gross level of activity as a way of showing that the growth in the business is still continuing, even though we see this episodic churn event from the consolidation in the industry. And another -- just a clarification question. You mentioned Verizon's customer, T-Mobile as a customer. Is AT&T a significant small cell customer today? Yes, we're building small cells for everybody. But obviously those two -- our total backlog is a little more than 60,000. So obviously, those two orders we got for 15,000 from Verizon and 35,000 from T-Mobile is the majority of our backlog. So that gets you to 115 minus five for T-Mobile. So 110 is kind of the addressable opportunity at the moment? I'm going to throw out the third and final survey question, and we'll come to this in a couple of minutes. Do you expect annual dividend per share growth for Crown Castle to return to the annual target rate of 7% to 8% after 2025. And it's just a choice of yes or no. So we'll come back to that in a moment. Fiber Solutions, is there -- which is -- so you have a small cell business, you have fiber solutions. Is there a significant macro sensitivities to that business. So if the U.S. goes into a recession, is that something that investors should be mindful of in terms of the possible slowdown or churn in that business? Or is it fairly durable relative to changes in the economic backdrop? What we've seen in the context of our business has been that the macro environment hasn't had a tremendous impact on our level of growth. We've generally been able to grow around 3% on the revenue line for fiber solutions through some varying macroeconomic cycles. I think that's because we've targeted what customer base we go after, which is more of a large-scale enterprise, government entity, financial service provider that have longer time frames that they had planned to. And the short-term implications of a recession and hopefully, what would ultimately be a mild one if it were to happen, I don't think impact the decision of those companies to invest in the movement of data across their business. So we have not seen tremendous impacts from macroeconomic situations on our Fiber Solutions business historically nor would we assume there would be significant one’s going forward. However, I would say, of course, we're subject to macroeconomic events. Like any other business, if companies pull back and want to save money, then they're going to pull back and want to save money. I think the difference is that, we really are selling -- the core value we're selling is the network itself. And it's hard to pull back on the network when your business is still operating because people are still generating more demand and more data and they want to move it around, they want it to go faster. And we are helping supply the underlying infrastructure to make that happen. So we don't -- again, we don't see a huge impact from a slowdown, although we might see some if there is a recession in 2023 or beyond. And one other question on small cells, just to pivot back to that for a moment. The CapEx for that business is sensitive to the level of co-location on the fiber relative to new nodes. How does that look in 2023 relative to what the experience has been over the last couple of years? To give a little explanation to that, when we build a small cell system, the initial build, we generate a 6% to 7% yield on invested capital. The majority of the capital that we spend is to build the fiber of the small cell. And it's not the cost of the fiber itself. It's the cost of digging up the street, bearing the fiber and putting the street back together. So when we add a second customer to an already existing system where we don't have to dig up the street and burry in a fiber, there's significantly less capital in those co-location type of builds than there are in the anchor builds that we do. And therefore, the returns are much higher in co-location. So when we add a second tenant, the entire system goes from 6% to 7% to low double-digit yields, which means the incremental yields are 20-plus percent. And that's because we've just -- the amount of capital we spend on a co-location is much lower. As we look out into 2023, the 10,000 nodes we are going to build are majority co-location. So we are going to double the number of installations we perform from 2022 to 2023, while adding about -- only about 10% more capital. And that shows the power of co-location. So double the activity and only add 10% of the cost. That will result in higher yields on -- obviously, on that capital because we'll get the same revenue generally for doubling the revenue and only getting 10% more cost. That's the business model we're in. That's how -- build good assets, lease them up over time, it results in good returns. Okay. So over 80%, 83% said yes. It would return back to the annual target rate of 7% to 8% after 2025 and 17% said no. Your answer on this question? Yes. So what we've said, again, our target is to grow our dividend 7% to 8% a year. The reason that we focus on the dividend is because that is the return we're giving to investors for all of the investments they've made prior to that date. And we want everybody to understand that we are focused on giving them their money back and a return on their money and growing it at 7% to 8%. Over the next two years, '24 and '25, we don't think we're going to get to that 7% to 8% because of episodic reasons, either a significant rise in interest expense and then the Sprint churn in 2025. So we believe we'll be under our 7% to 8% growth over the next two years. But as we [indiscernible] 2026 and beyond, there is nothing we've seen that is systemic in our business that would lead us to believe that the growth rate would be any lower than 7% to 8%. And we're very excited about the long-term growth in this business because not only is tower is a great business model that continues to grow for all the reasons we've discussed. But we have all of these new investments in small cells that we think will lease up and drive significant growth in our business, and that's a great place to be. Because as good as the tower business is, nothing grows forever for all the time. You always need to be thinking about what's next for your business, and we think we found something that's really attractive that has the same customer base, the same underlying business drivers, the same contract structures and the same basic value creation, while delivering the same value to our customers, which is lower their cost of implementation and operation by sharing the cost of that implementation across multiple customers. That seems like a great business model for us is to have every way of attacking the growth in infrastructure in the U.S., and we think we're primed to do so. Is there a risk that it could be below zero that the dividend could actually get trimmed over the next couple of years between now and getting back to your -- the aspirations after 2025? Yes, it's actually not my decision on what the dividend does, that’s a Board decision, so I can't promise what they'll do, but we don't see anything that would lead us to believe that cutting the dividend is in the cards either. And maybe finally, just in terms of capital allocation, net debt leverage, is there any room over time to bring that up? You've been around that 5 times level for a while, any opportunity to move it? Or conversely, do you feel like it's more prudent to actually bring it down? We believe our business can withstand more than 5 times debt-to-EBITDA leverage and still operate very well. What limits us is, in essence, Moody's has a rating on us that says, if we get above 5 times and the way we talk about it, they would say that, that would potentially lead to a downgrade. That's recently shifted a little bit because they have recently put us on an outlook of positive. So we're not sure how that's going to end up. We'll see. If they were to move their targets, I think we would move where our leverage is, if they went up, we would probably move our leverage, because we believe that maintaining investment-grade rating is really important, but that we believe that having more debt is totally sustainable and lowers our overall cost of capital, which is really important in a business that spends money like ours does as the cost of capital matters a lot. So we want the lowest cost of capital, which we think is the debt market and we think we can withstand more leverage. And our business model is sustainable, predictable and growth. And we think that, that leads to a better leverage profile. And if you get that flexibility to take that leverage up what would be the priorities in terms of how to use that extra financial flexibility for [indiscernible] Whatever drives the most long-term dividend per share growth, and we believe that is investment in new assets. That generate the types of returns that we talk about with things like towers and small cells that we're investing in currently, which are generating, like I said, up to 15% returns. Those are sizable over and above our cost of capital returns, and we will continue to want to invest in our business. If that changes and those returns either come down or the repurchase of our stock would be more beneficial to the long-term dividend per share growth, then we would shift our priorities, but that's not what we've seen to date. [indiscernible] ask you about the buybacks, because there was a time where Crown was more focused on buybacks. So is that something that is more of a discussion? Or at this point, it's just too premature. Yes, it's never premature. We are always discussing it. But we've -- when we've modeled out our business, we see that continuing to invest in the assets drives the best outcome over the long term. And that's what we'll continue to focus on.
EarningCall_1463
And at this time, I would like to turn the conference over to James Connelly, Senior Vice President of Corporate Communications. Please go ahead, Mr. Connelly. Thank you. Good morning, everyone, and welcome to Aircastle Limited's third quarter 2022 financial update call. With me today are Mike Inglese, Chief Executive Officer; and Roy Chandran, Chief Financial Officer. Other members of the management team are on the line and they'll be available during Q&A. We'll begin the presentation shortly, but I'd like to remind everyone that this call is being recorded and a replay will be available through our website at www.aircastle.com. There you can also find the press release and PowerPoint presentation that accompany this call. I would like to point out that statements today, which are not historical facts, may be deemed forward-looking statements. Actual results may differ materially from the estimates or expectations expressed in those statements. Certain facts that could cause actual results to differ materially from Aircastle Limited's expectations are detailed in our SEC filings, which can also be found on our website. I'll direct you to Aircastle Limited's press release for the full forward-looking statement legend. Thanks, Jim. Good morning, everyone. Thank you for joining us. I'd like to start off by wishing everyone a happy and healthy 2023. As per our usual agenda, I'll kick off this call by sharing a few brief observations on the global aviation marketplace along with some highlights from our third quarter. Roy will then provide more detailed color on our financial results, after which we're happy to take some questions. Last month, IATA shared its global outlook for air transport, which forecasted airlines returning to profitability this year. I believe this optimism is rooted in the continued demand for travel and by the resiliency airlines have shown as they manage through significant economic headwinds. Earlier this week, IATA released their latest air passenger market analysis reporting that industry wide RPKs are at 75% pre pandemic levels with a 41% increase from 2021. Despite headwinds due to inflation, fuel prices, interest rates and foreign exchange rates, airlines continue to find ways to meet growing demand for travel while managing their costs. Strong demand for travel is seen in North America, Latin America, Europe, India and many parts of Asia, regions where Aircastle serves a significant number of customers. While the situation in China remains volatile with local easing of restrictions being somewhat offset by new restrictions on Chinese travelers, the broader Asia Pacific region experienced a 426% increase in international RPKs during our fiscal third quarter versus the same period in 2021. The creativity and resilience we're seeing from our customers is similar to what we observed during the 2008 financial crisis. The airlines weather challenging times because their skilled operators who adapt to meet the continued demand for travel allowing to the overall aviation sector to grow. We've seen more key evidence of this growth in the past few weeks. Major airlines and lessors have placed large orders for new narrow-body aircraft and wide-body aircraft with Boeing and Airbus providing a strong indication of Aviation's long term growth trajectory. Although manufacturers are happy to take new orders, they continue to be impacted by supply chain issues for which there has been little measurable improvement. This means that airlines continue to look to leasing existing aircraft for lift further proving the unique relevance of Aircastle's position in the market. Because demand exceeds supply for new narrow-body passenger aircraft, we're seeing steady requests for lease extensions on our planes. That said, it's still a challenging landscape for lessors and customers alike. Relatively strong U. S. dollar and high fuel prices prevent formidable headwinds. 2023 also presents the risk of recession as inflation and interest rates remain elevated. Yet favorable travel volumes continue despite these headwinds and I'm pleased to report that Aircastle achieved a very profitable quarter in our fiscal third quarter. We finished the third quarter with $50 million in net income, $258 million in total revenue and adjusted EBITDA of $240 million. Roy will provide more details on these results in a minute. But I believe the deciding factor in this quarter's success was effective transaction execution by our team. As to be expected in an environment of interest rate spikes, increased debt costs have somewhat slowed the overall pace of aircraft trading. Despite this, we continue to see our momentum from the second quarter, acquiring another 7 narrow-body aircraft including E2s, two A321neos and A320neo and a 737-MAX 8. Clearly, our portfolio growth strategy is focused on new technology aircraft. Two-thirds of the acquisitions Aircastle has made over the last 12 months have been new tech. We've achieved a 55% net book value increase in the best new fuel efficient emissions narrow-body aircraft sought by our customers. While the industry's net 0 goals are ambitious and heavily focused on the use of sustainable aviation fuel, the limited availability of staff has forced airlines to add new tech aircraft to help reach sustainability goals. Acquiring new aircraft technology remains extremely competitive. Narrow-body aircraft attracts a good credits, attract many investors. I believe our ability to execute in such a challenging landscape is testament to our experienced team and the strong relationships we've built among the sectors airlines and trading partners. Not having a large forward order book also gives us flexibility to deploy capital and pursue the most attractive assets in the market. Our competitors strengths are ability to execute quickly and our reputation among counterparties for reliability and professionalism. On the portfolio management side, we sold 8 aircraft and other flight equipment for a gain of $53 million. Among these were the sales of two 747 freighters, and a 777. After these sales, our narrow-body passenger aircraft make up 91% of our portfolio. Shifting from aircraft trading to finance, we announced a new $450 million secured financing facility in November, which bolsters our conservative debt profile during a challenging interest rate landscape. After many years of success in unsecured borrowings, our deep capital markets team has cultivated strong banking relationships. Lenders appreciate our track record, our investment grade ratings and the opportunities afforded to us by our unique ownership structure with Marubeni Corporation and Mizuho Leasing. It's understood that there are near term headwinds for aviation but Aircastle's deep team possessing multi cycle experience is well suited for whatever 2023 brings our way. We're confident we can creatively build aviation solutions for our customers while maintaining a risk focused objectivity and broader aviation marketplace to ensure that we're always protecting our asset values. Our growing fleet of new technology aircraft keeps us addressed of the technology transition taking place across our customer base. We're strengthening the value of our portfolio, while also helping customers achieve their sustainability goals. Because of our conservative balance sheet, our investment grade rating and the strong support of our shareholders, we continue to be well positioned for the future. For the third quarter, we reported net income of $50 million and adjusted EBITDA of $240 million. Total revenues were $258 million including gains on sale of flight equipment of $53 million. We also successfully collected $24 million of outstanding letters of credits related to former Russian leases basically everything that was still outstanding. Year-to-date operating cash flow was $344 million, a 27% improvement from prior year reflect stabilized customer performance as does our 39% decrease in AR over the same period. We invested $298 million this quarter for 7 narrow-body aircraft, 6 of which was new technology. The 8 aircraft sales Mike mentioned brought in proceeds of $163 million. The average age of aircraft sold was 18 years. Transactional impairments were largely offset by related maintenance and other revenues, as well as a $24 million received from Russia-related letters of credit. Excluding the effective impairments, expenses are down 3% compared to third quarter of 2021, primarily due to lower maintenance costs resulting from fewer assets on the ground. As Mike mentioned, we successfully closed a $450 million secured aircraft financing facility. This facility has a 7-year term and we expect it to be funded over the next three months. Continuing with our capital structure, our net debt to equity stood at 2.7x, down slightly from last quarter. We finished the quarter with total debt of $4.5 billion of which 85% was unsecured. The average -- weighted average rate on our debt was 4.24% a slight uptick from last quarter. Continuing on liquidity as of January 6, we had total liquidity of $2.3 billion. This includes $1.7 billion of undrawn facilities, unrestricted cash were $100 million -- $100 million in contracted sales and projected 12 months adjusted operating cash flows of $400 million. Our next major debt repayment is in April, but we expect to repay sometime between now and maturity. Looking ahead to 2023, new technology narrow-body aircraft will be a high priority for our portfolio. As we constantly trade in the market, we expect to adhere to allow the usual conservative leverage while maintaining forward commitments. With our long term focused investment grade rated shareholders, we are optimistic about 2023. Great. Thanks. Good morning. Roy, you mentioned the recent secured facility. I saw -- I think you gave an interview in Air Finance Journal. You talked about the decision to add recourse to that. So I'm sort of wondering if you can talk through of your secured debt, how much has recourse? How much is non-recourse secured? Just very curious for an investment grade company to borrow secure with recourse. We don't see that a lot. So I'm wondering if you can talk maybe about what that saved you by offering that recourse. Maybe you can just walk us through that. Sure. I think the -- maybe that report was slightly off. I mean, all our secured financings are recourse. We've traditionally traded non-recourse for recourse and used effectively the benefit of recourse in our investment grade status, some operational flexibility. So, I wouldn't say it's pricing obviously matters, but at the end of the day for us the flexibility around moving assets around trading assets, not having to go back to our lenders for consents I think was important. And so we have a very wide range of operating flexibility within our terms. So if you go back to all our financings effectively have been recourse, and we haven't done anything, which is really purely non-recourse. So when you think about for this most recent transaction, a secured recourse facility versus issuing similar duration unsecured bonds, how much do you think you saved going the secured route? I'd say given where when we did the transaction, my guess is somewhere between 100 to 150 basis points. That's a bit of a moving target obviously, right? When we decided to enter the markets, the markets were much more volatile subsequent to that, a couple of peers have been to the market to settle down. But I'd say on average, we've always looked at the delta between unsecured bonds versus secured bank transactions, usually in that range, 100 to 150 basis points. And I know your spreads were obviously, they were way too wide. They've come in a bunch. They're still probably too wide, certainly in your opinion. And I think I shared that view. So when you think about the market now going forward for 2023, how much more flexibility do you think you have to issue secured if you were to do a deal tomorrow, do you think it would be secured or do you think are you getting more comfortable where unsecured yields are? And how should we think about what's that next deal look like? Is it going to be secured or unsecured? I think we're never comfortable where rates are, right, as an issue, we always wanted to be lower. There are some natural constraints on secured transactions. We've always adhere to trying to keep secured within sort of a boundary of less than 20%. Right now we are 15, so theoretically we have some capacity. The flipside is we do want to be a frequent issuer in the unsecured market. The unsecured market have got the deepest form of capital. So I think all things being equal, we have enough capacity to deal with our near term maturity. We'll look at the markets and plan sort of to be in the market at some point in the next six months. When and exactly when I don't know. But really, we, as reasonably frequently sure, we are prepared to kind of go at short notice and I think we'll wait for the market to sell down a little bit more. But I'd say that will be our first quarter call. We're also looking at some alternative financing in other markets, but I think first priority is always to maintain some liquidity in the unsecured markets. Great. Thanks. And then the last questions for me. Mike, you sort of mentioned average age of the portfolio right continues to come down long term trend at least, right? So when it came down this quarter, how important is it that you continue to drive down the average age because you know, you still have your mid-life strategy, but obviously more of what you're buying is newer generation technology and so forth almost all of what you're buying. So I'm just sort wondering how you're thinking about the average age of the portfolio and where that may evolve to? Yes. I think practically speaking, as we've begin investing in new tech over the last year or so and as the technology in the marketplace will grow, simplistically thinking if we add new-tech and some old tech and you roll forward reasonable investment levels for four or five, that may change your mix because if you think about three or four years from now, there'll be mid aged new tech aircraft, which will probably become the focus of our investment target. So the age of what we're buying will probably increase as market penetration of new tech increases. So realistically going from somewhere between 10 and 11 down to somewhere around nine to 10 is sort of how I think will most likely wind up. So it won't be -- we're not going from 10 to two and we're probably not going from 10 to five. Yes. Good morning. A question on the very impressive gain on sale? I believe you said it was two 747s and a 777? And so was that a net gain on sale? And is there some triggering that created the $30 million, looks like a $30 million impairment in the quarter? So yes, the gain on sale of the 747, and one of the 747 and the 777 were assets that came out of Russia and more previously impaired. So just to be clear, it's different accounting period realities for those assets. Okay, that's helpful. And it looks like in the quarter, there was a pretty sharp uptick in maintenance revenue relative to overall lease rental. Is that simply a function of utilization improving? Are you seeing a higher percentage of your assets being maintenance payers, maybe a little bit more color on maintenance revenue? Yes. I think typically for us, Doug, the maintenance revenue that gets recognized is more driven by transactional activity in one lease pending and another lease beginning for the sale of an asset. So it wasn't reflective of a change necessarily in the quarter of maintenance collections from all of our customers who are maintenance payers. Okay. And then a quick last question on operations, very impressive utilization number. At this point in the COVID cycle, I guess, and to what extent do you still have airlines that have significant deferrals or most of them back to where they should be? What do you expect going forward particularly with Asia Pacific reopening? So when I think about deferrals in the context of our customer base, two of our significant customers in Southeast Asia, we did in essence, lease restructurings, that will defer a collection of revenue over a long period of time. And so with what's happening in that part of the world most recently, which has been the part of the world that has lagged from a recovery, we're seeing good positive momentum in the context of those airlines getting back on track. Great. And maybe a last question linked to Mark's question earlier. Your average debt tenure 2.4 years, your lease term now average lease term extended nicely to 5.1. Conceptually, should those two numbers be a little bit closer or are you somehow, I guess, getting comfort with your shareholders that works? No, Doug, I mean, I think, I'd say that those two numbers should be closer and end of the day think we've always tried to push out debt maturities as far as we can. But in terms of financings end of the day, how steep is the curve going from sort of 3% to 5%, 5% to 7% percent and ultimately 7% to 10s, right? So our long term game plan is to try to continue to push that out and bring those two things more in sync. In a perfect world, you want them to be close, but that's tough to do. Right, understood. Well, I'll save the rest of my questions for Dublin. Thanks very much for the presentation and the granular information. [Operator Instructions] And it appears that there are no additional questions at this time. I'll turn the conference back to James Connelly for any additional remarks. I just want to thank everyone for joining today. Please reach out if you have any questions and hope you have a great day.
EarningCall_1464
Hello, ladies and gentlemen. Thank you for standing by for Li Auto's Third Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. Today’s conference call is being recorded. I will now turn the call over to your host, Janet Zhang, Investor Relations of Li Auto. Please go ahead, Janet. Thank you, Matt. Good evening, and good morning, everyone. Welcome to Li Auto’s third quarter 2022 earnings conference call. The Company's financial and operating results were published in the press release earlier today and are posted on the Company's IR website. On today's call, we have our President, Mr. Kevin Yanan Shen; and our CFO, Mr. Johnny Tie Li, to begin with prepared remarks. Our Founder and CEO, Mr. Xiang Li; together with our senior management, Mr. Donghui Ma and Mr. Yan Xie, will join for the Q&A discussion. Before we continue, please be reminded 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 involve recurrent risks and uncertainties. As such, the Company's actual results may be materially different from the views expressed today. Further information regarding risks and uncertainties is included in certain filings of the Company with the U.S. Securities and Exchange Commission and the Hong Kong Stock Exchange. The Company does not assume any obligation to update any forward-looking statements, except as required under applicable law. Please also note that Li Auto's earnings press release and this conference call include discussions of unaudited GAAP financial information, as well as unaudited non-GAAP financial measures. Please refer to Li Auto's disclosure documents on the IR section of our website, which contain a reconciliation of the unaudited non-GAAP measures to comparable GAAP measures. Thank you, Janet. Hello, everyone, and thank you for joining our call today. I will review our third quarter key highlights. In the third quarter, we navigated our model succession and launch cycle as well as the challenging macro environment and supply chain constraints. Against this backdrop, we delivered 26,524 vehicles, up 5.6% year-over-year. Despite our supply chain bottleneck, we delivered over 10,000 lead airlines in September, the model's first four months of production. This marked the first time that the Chinese branded premium model priced over RMB400,000 achieved monthly sales of more than 10,000 vehicles, demonstrating Li L9 as a topic among full-size SUVs for family users. This success was due to the exceptional strength of our team, their outstanding management of the Li L9 ramp-up process and their skillful collaboration with our supply chain partners. As Li L9 continues to surpass user expectations with class-leading features in drivability, safety, interior space, passenger experience and smartness, demand remain robust, providing constantly strong order inflow for the model. Li L9 has been the sales champion among full-size SUVs in China since its delivery started. Benefiting from Li L9 strength, our total delivery in October reached 10,052, representing a 31.4% year-over-year increase. This followed by a record breaking 15,034 vehicle deliveries in November. As always, we would like to extend the sincere gratitude to our over 200,000 Li ONE users, we will continue to adhere to higher the industry service standards and continue to improve the performance of Li ONE through OTAs. On September 30, we launched Li L8, a six-seat premium family SUV that succeeded Li ONE. We also unveiled Li L7, a seven-seat flagship family SUV on the same day. We commenced the deliveries of Li L8 in November. Let me provide more details of this vehicle. Li L8 employs our new generation all-wheel drive range extension system and boast over 100 features in their standard configuration. It's available in two trims: Pro and MAX, providing users with flexible choices of smartness. The two trims are harnessed respectively with Li AD Pro and the Li AD MAX, autonomous driving systems. Pro is powered by the Horizon Robotics Journey 5 chip with 128 tops of computing power, while MAX is powered by the dual Orin-X chips with 508 TOPS of computing power. In addition, the two trims are equipped with innovative smart space system: SS Pro and SS MAX, featuring a first-roll full-screen interactive system and a five-screen three-dimensional interactive system, respectively. These packages bring a new level of driving and entertainment experience to smart electric vehicles. We are pleased that Li L8, numerous class leading feature have delighted its first batch of users, and we believe that their satisfaction for the vehicle has broadly exceeded their expectations. We are confident that Li L8 will stand among the finance option for six seaters priced over RMB300,000. And together with Li L9, the sales campaign of full-sized SUVs in China; and the Li L7, which we believe will be a top choice among five-seats SUVs priced over RMB300,000. We expect to captivate a broader range of family users with differentiated needs and gain a larger market share in the RMB300,000 to RMB500,000 price segment. We are encouraged by Li L9’s continued strong sales performance and the solid demand for Li L8. But considering the ongoing supply chain uncertainty, we expected fourth quarter deliveries to be in the range of 45,000 to 48,000 vehicles. We will continue to collaborate closely with our supply chain partners to react quickly to changes and to mitigate potential risks. During the third quarter, we continued to demonstrate our strong commitment to vehicle safety. According to the vehicle safety evaluation results released on November 4 by the China Insurance Automotive Safety Index, or C-IASI, Li L9 obtained the G rating, the highest safety rating in three out of four evaluation categories: occupant safety, pedestrian safety and assistance safety. In the category of crashworthiness and repair economy, Li L9 received an M rating, one of the top results received by premium vehicles tested by C-IASI since 2017. In addition, it was the first domestic full-size SUV tested for 25% front offset impact on both the driver and passenger sides and achieved the G rating for both tests. Thanks to its ultra-high-strength body structure, Li L9 also demonstrated class-leading performance with the ability to withstand a peak force of 116,475 newtons in the roof strength test. Its roof can withstand a weight of 11.8 ton on the side effectively preventing cabin deformation and the safeguard, a relatively large head space for drivers and passengers to survive in case of accidents. We continue to -- we continually improved our vehicle's performance and features through OTA after their delivery. In early November, we released our OTA 4.1 upgrade for Li L9, further enhancing user experience with our upgraded Li AD autonomous driving system and smart in-car voice assistant, Li Xiang, Tongxue, as well as improved smart space interactions and entertainment experiences. In particular, the vehicle's three 15.7-inch 3K automotive-grade OLED screens can now project the same events and all game from the three different camera angles, transforming Li L9 into a great sports launch for families and friends to watch games such as the ongoing FIFA World Cup. To create successful products, we have two core goals. Firstly, for consumers, we choose to exceed their needs rather than merely meeting them. Secondly, as a company, we aim to achieve healthy gross margin and self-sustaining cash flow, which will allow us to continually invest in our dual growth engine of R&D and business capabilities. Especially, our R&D efforts will be directed more comprehensively across products, platforms and systems with a long-term goal of growing into a world-class technology company. Our business capability includes commercial supply and organization capabilities. With continued investment in R&D and business capability, supported by our healthy gross margin, we will continue to pursue product and commercial success and foster a healthy long-term development model. This flywheel has been the strategic focus since our founding, and we believe will remain our strategy going forward. By understanding this business model, you will understand the Li Auto more. Our supply chain remains one of the most significant variables with respect to our deliveries. We are accelerating supply chain deployment and optimization to build our resilience for fluctuations and support our rapid growth sales. Importantly, we are committed to extending our in-house development and manufacturing capability vertically along our supply chain. Through our forthcoming self-owned manufacturing base and the majority owned JVs, we expect to be able to self-produce both ranging tenders and the five-in-one electric drive units that can support our EREV delivery target. On the BEV side, we have commenced the construction of a semiconductor manufacturing base in high-tech zone of Suzhou, Jiangsu province in the third quarter. It will focus on R&D and production of automotive-grade power module based on the third-generation semiconductor material silicon carbide. The power module is a core component of our self-developed [800-volt] (ph) electric drive system. Alongside our dedicated investment in supply chain, we continue to expand our direct sales and service network and increase our brand awareness with upgraded brand image to fuel our business expansion. As of November 30, 2022, we had 276 retail stores, covering 119 cities as well as 317 servicing centers and Li Auto authorized body and paint shops operating in 226 cities. During the third quarter, we also started to open retail stores in places other than shopping malls, such as automotive theme parks to diversify our locations and reach more varied target users. The retail stores we opened at Hangzhou [indiscernible] auto theme park in September is a good example, featuring our new design language and own colors, it creates a welcoming interactive space for visitors. It also enjoys strong food traffic due to its excellent location and word-of-mouth publicity. In addition, this store also offers customers a comprehensive and convenient experience with combined showroom and delivery center functions. The expansion and upgrade of our direct sales and servicing network have boosted both our brand recognition and our ability to fulfill user demand for our compelling products, which we are confident will drive meaningful sales growth going forward. We will continue to innovate new retail formats, finding new ways to attract more users, while providing them with better services and experiences. Moving to R&D. We believe R&D capability lies at the core of product competitiveness as we scale our company from one to 10. Therefore, we insist on full stack self-development of core technologies such as electric drive, intelligence space and the autonomous driving system. We have spared no effort in solidifying our leadership in the EREV space with continued investment in our new generation range extension system. In addition, we are actively self-developing the key building blocks of our 8-volt HPC BEV platform, including the power chip, power module, electronic control unit, electric motor and transmission system, aiming to be one of the first automaker to roll out HPC BEV vehicles. We are also proud to lead the industry in Smart Space R&D. For example, we self-developed our Smart Space Li AI system powered by MIMO-Net, a fixed-zoom human voice-enhance network; and the MVF-Net, a multi-view fusion network. Li AI can help create accurate sound perception in a complex acoustic environment and identify complicated gestures, enabling an unparalleled in-car entertainment and interactive experience. With respect to autonomous driving as of November 30, more than 170,000 family users have enjoyed our highway NOA feature. We have further enhanced our vehicle's ability to perceive dynamic obstacles and static road structures in a complex environment, as well as their ability to forecast traffic participants' action. We were the first in the industry to extend the concept of 3D hypothesis 2D verification to multi-mode sensor. And the Li L9 was the first to realize highway NOA based on an NVIDIA Orin SoC chipset. Meanwhile, we have partnered with Tsinghua University and MIT to complete the world's first public project to construct high precision maps in real-time. Intelligent manufacturing is another core competence for any successful automaker and another area in which we excel. First, we have industry-leading manufacturing equipment. Our fully self-developed manufacturing management software, Li MOS can greatly improve production efficiency and quality with precision control during the entire automotive manufacturing process. This system will be implemented in all our future factories, shortening new factories deployment cycle by more than three months. Our R&D efforts are not limited to building a great car, but also how to make it. We use vision sensors and algorithms to precisely control the workflow of hardware equipment in order to realize flexible production and intelligent inspection. As we strive to enhance our R&D and manufacturing capabilities, we also aspired to make a positive environmental and social impact through our sound government structure and the dedication to sustainable development. In September 2022, we received an MSCI ESG rating of AA for the second year in a row, maintaining our leadership position in the automotive industry in terms of ESG performance. Moreover, following the earthquake in Luding County, Sichuan province on September 5, we made a donation to help the affected people and to support disaster relief efforts. We hope to play our part as a corporate citizen and a member of the community by helping people in need. We look forward to sharing more of our ESG endeavors in our next ESG report, which we expect in the first half of next year. In addition, we have -- we are pleased to be included as a constituent stock in the Hang Seng China Enterprise Index, effective December 5. This is a strong recognition of our underlying strengths and investment value. Lastly, as you may have seen from today's press release from January 1, 2023, I will no longer serve as the Company's President. I will spend more time to support the Company's new round of organizational upgrades to prepare for its future. In the future, our CEO, Li Xiang, will take over the responsibility of sales and services. Our newly appointed President, Mr. Ma Donghui will be responsible for the overall closed loop management from product R&D to procurement and supply, production and manufacturing and quality. Xie Yan, our new CTO will lead the Company's R&D team to explore the most advanced underlying technologies in the smart electric vehicle industry. I would like to thank our investors for the support and trust they have placed in Li Auto and myself. I firmly believe that Li Auto will continue to achieve great results under the leadership of the new management team and continue to lead the smart new energy vehicle industry in China. With that, I will turn the call over to our CFO, Johnny, for a closer look of our financial performance. Please go ahead. Thank you, Kevin. Hello, everyone. I will now go over some of our financial results for the third quarter of 2022. To be mindful of the length of this call, I will address financial highlights here and encourage you to refer to our earnings press release, which is posted online for additional details. Total revenues in the third quarter of 2022 were RMB9.34 billion or US$1.31 billion, representing an increase of 20.2% from RMB7.78 billion in the third quarter of 2021. This included RMB9.05 billion or US$1.27 billion of vehicle sales in the third quarter of 2022, up 22.5% year-over-year and 6.6% quarter-over-quarter. This increase was mainly due to our delivery of Li L9, starting in late August, which raised our average selling price in the third quarter of 2022. Revenues from other sales and services were RMB296.4 million or US$41.7 million in the third quarter of 2022, representing a decrease of 23.9% from the same period last year, an increase of 19% from the second quarter of this year. The year-over-year decrease was attributable to the sales of automotive regulatory credits in the third quarter of 2021, which didn't recur in the third quarter of 2022. The quarter-over-quarter increase in revenue from other sales and services was mainly due to the increased sales of accessories and services in line with higher accumulated vehicle sales. Cost of sales in the third quarter of 2022 was RMB8.16 billion or US$1.15 billion, representing an increase of 36.8% year-over-year and an increase of 19.1% quarter-over-quarter. The increase in cost of sales was mainly driven by higher average cost of sales due to our delivery of Li L9 starting in late August and a provision related to Li ONE as we lower its order forecast considering the stronger-than-expected market demand for Li L9 and our accelerated launch of Li L8. A provision in the amount of RMB802.8 million or US$112.9 million was made based on our updated order forecast for Li ONE after the launch of Li L9 and Li L8. Gross profit in the third quarter of 2022 was RMB1.18 billion or US$166.2 million, decreasing 34.8% year-over-year and 37.1% quarter-over-quarter. Vehicle margin in the third quarter of 2022 was 12% compared with a 21.1% in the third quarter of 2021 and 21.2% in the second quarter of this year, mostly due to the provision related to Li ONE as mentioned. Excluding this impact, the vehicle margin was 20.8% in the third quarter of 2022. Going forward with our production ramp-up and the responsible cost management, we expect to realize greater economies of scale and drive cost down further, putting us back on track to hit our profitability inflection point. Gross margin in the third quarter of 2022 was 12.7% compared to 23.3% in third quarter of last year and 21.5% in the second quarter of this year. Operating expenses in the third quarter of 2022 were RMB3.31 billion or US$465.6 million, increasing 73.4% year-over-year and 15.9% quarter-over-quarter. R&D expenses in the third quarter of 2022 were RMB1.8 billion or US$253.6 million, up 103.1% year-over-year, and 17.8% quarter-over-quarter. The year-over-year increase was primarily driven by increased expenses associated with future models, as well as increased employee compensation as a result of our growing number of R&D staff. As quarter-over-quarter increase was primarily driven by increased expenses associated with the future models. Selling, general and administrative expenses in the third quarter of 2022 were RMB1.51 billion or US$211.9 million, up 47.6% year-over-year and 13.8% quarter-over-quarter. The year-over-year increase was primarily driven by increased employee compensation as a result of growth -- of the growth in our staff headcount, as well as increased rental expenses associated with the expansion of the Company's sales network. This quarter-over-quarter increase was primarily driven by increased marketing and promotion activities and increased employee compensation as a result of the growth in our staff headcount. Loss from operations in the third quarter of 2022 was RMB2.13 billion or US$299.4 million compared a loss of RMB97.8 million in the same period last year and a loss of RMB976.5 million in the second quarter of this year. Net loss was RMB1.65 billion or US$231.3 million in the third quarter of 2022 compared with RMB21.5 million in the third quarter of last year and RMB641 million in the second quarter of 2022. And now turning to our balance sheet and cash flow. Our cash and cash equivalents, restricted cash, time deposits, short-term investments, long-term time deposits and long-term financial instruments that were included in long-term investments totaled RMB55.83 billion or US$7.85 billion as of September 30, 2022. Net cash used in operating activities in the third quarter of 2022 was RMB508.3 million or US$71.5 million. The change in net cash used in operating activities over both the third quarter of last year and the second quarter of this year was mainly due to the increase in payment related to inventory purchase, partially offset by the increase in cash received from the customer. Free cash flow was negative RMB1.96 billion or negative US$275.3 million in the third quarter of 2022. And now for our business outlook, for the fourth quarter of 2022, the Company expects deliveries to be between 45,000 and 48,000 vehicles, representing an increase of 27.8% to 36.3% from the fourth quarter of last year. The Company also expects fourth quarter total revenues to be between RMB16.51 billion and RMB17.61 billion or US$2.32 billion and US$2.47 billion, representing an increase of 55.4% to 65.6% from the fourth quarter of last year. This business outlook reflects the Company's current and preliminary view on the business situation and market condition, which is subject to change. Going forward, we believe our navel and collaborative corporate culture, execution discipline and strong balance sheet will allow us to face challenging markets head on and continue to deploy capital and resources efficiently to focus on our products and innovation initiatives and drive our long-term growth. [Foreign Language] So my first question is about vehicle sales. So how should we think about the stable monthly run rate the sales of L7, L8, L9 in aggregates next year? Could the sales of the whole L family models stay at around like 25,000 to 30,000 level on a monthly basis as previously expected? And in the meantime, considering the decline in store traffic in October and November due to the COVID, does Li Auto's order backlog so far remains strong and adequate enough to bolster the delivery momentum into first quarter 2023? Yes. Tim, you want me to answer your first question first, right? Okay. About the outlook of L9, L8 and L7, so we can only make a judgment based on the competitiveness of this product and also outlook based on the market size of each of these product segments. So, our outlook is that for L9, the stabilized monthly sales should be around 8,000 to 11,000. That's our estimation; and for L8 will be 10,000 to 15,000, yes -- 14,000; and L7, now it's quite early to do estimations. So basically, the -- for the Q1 outlook, we believe the beginning of Q1, our backlog will continue to drive strong delivery performance. And of course, after Chinese New Year we need to bring more order in. We have strong confidence that in Q1 we'll continue to beat the overall EV market performance. But Tim, as you mentioned, there are some factors that's beyond our control, like COVID, but we believe we will beat the overall EV market performance. [Foreign Language] So my second question is about the battery EV, the pure EV. With the current update on Li Auto BEV pipeline, where the Company followed its original plan to launch two BEV models next year within 2023? [Foreign Language] So, we were pretty certain that next year, we'll be releasing our first electric vehicle. And so, the two big events are next year. One is the release of the first electric vehicle and the other one is the delivery -- commence delivery of L7. [Foreign Language] Now let me translate my two questions. The first question is about the pricing and competition. Recently, Tesla has announced a meaningful pricing cut in Chinese market. What is Li Auto's response to that? And how should we examine such pricing competition next year? Is it expected to be more severe? The second question is on the supply chain management. As Kevin mentioned in the briefing, there exist supply chain uncertainties. Could you please clarify what's the key bottleneck for now? And as the COVID-related policies changed a lot recently, what is the expected impact on the auto production in the next several months? Thank you. Thank you, Olivia. Yes, let me take your question. Your first question about the price cut from Tesla side. Actually, we see a little impact on our order flow because our products right now, L9 and L8 is -- the price segment is higher than Tesla's main selling model, yes. And we would expect the same kind of situation in next year. So yes, we still have a strong confidence that in this industry turmoil we'll continue to lead. For your second question, how about the supply chain, yes, of course, we are glad to see the new COVID policy that ultimately -- the -- with the pandemic will resolve, actually, the supply chain will back to normal. But as we should all know that for the next two, three months, based on the trend we see in other foreign countries once the policy change, we may see here and there, the manpower shortages. Right now, we already see some of these kind of manpower shortages impact our production, especially in our supplier side. Yes. So we are working closely with our supply chain partners, try to mitigate all these risks, and we even start to prepare some of the workforce by ourselves. Whenever there is a shortage, we'll send the workforce to help our supply partners. Yes. [Foreign Language] My first question is regarding your decision to make silicon carbide by yourself. And compared to your peers, some choose to build the internal capacity for factory, some decide to design chips by themselves, but what is the decision -- why is the decision is made for this capacity build? Thank you. Thank you, Ming. This is Kevin. Let me take this question. Actually, just to clarify, we are not in Suzhou manufacturing the silicon carbide chip set. Actually, we are making the power drive module with the chipset. So while we choose to design our own power module, it's because the power module is closely integrated into our five-in-one electric motors and our three-in-one electric motors. So therefore, the thermal solution and the size of this module are very important for our competitiveness and energy efficiency. That's why we choose to build this module bus design and build these modules by ourselves. Yes, just to clarify. And my second question, the new energy vehicle [indiscernible] will change in Shanghai in 2023. So could you remind us, what is the current contribution from Shanghai area? And how do you see the impact after the policy change? Besides that, would you speed up your battery EV launch in order to make the potential overload after the priority change? [Foreign Language] Thank you. So Shanghai accounts for 6% to 5% of our sales volume. Yes. So of course, the policy change, of course, will have some impact on our sales in Shanghai. But actually, as we should all know, most of the Li Auto customers are not buying a new car. They are kind of upgrading their cars. So in theory, we already have the car plate, so therefore we are actively working with Shanghai -- with our Shanghai to build a new sales strategy for next year to mitigate the impact of this policy change. But again, overall, Shanghai is only like 6% of our sales total volume. And about the BEV, actually just now BEV already in the scopes that next year, we're going to have a launch of our first BEV car, yes. [Foreign Language] My first question is about Li ONE has got some cost about in RMB800 million cost for [indiscernible] so what is the principle for this cost? And how can we expect for the future potential cost of produced ONE? And my second question is about metric organization, could you please talk more about that? Thank you. I will take your provision question. This is Johnny. And for this provision, it's already set to the raw materials, which means the parts already in our inventory or the purchase commitment we made to our suppliers for those inventory and parts commitment, we don't plan to make it into vehicles in the future. So, the provision was based on the lower of cost and net realizable value based on our estimate and negotiation with the vendors. So it's an estimate. So, when I finally realized in the next two quarters, there will be some minor adjustment to the final amount comparing with quarterly gross margin is not very significant. [Foreign Language] Actually, since we founded Li Auto, we've always dreamed of becoming a $1 trillion or RMB1 trillion company. And as you can see, next year we're expecting to become RMB100 billion company already. So personally, I have never run -- built a company from $0 billion to $1 billion -- $100 billion company from scratch. And most of my colleagues have not had that experience either. Most of my colleagues, either they come from companies that are smaller than that or they come from companies that became that ours years ago or they work off of a remote office does not headquartered in China. So we have seen this issue a long time ago. So since 2019, we've been starting to study software and hardware companies that have reached the size of RMB1 trillion very, very deeply to see how they managed their business at different stages and what we can learn from them. And one thing in common that we've seen is that, they've all transformed to a matrix organization when they reach the level of about RMB10 billion. And so for Li Auto, when we started from zero to one, speed was efficiency, speed meant everything. But as time went on, we saw that in a very long value chain where quality and efficiency is very important. In our one to 10 stage, quality is efficiency. So a successful enterprise will need to be able to -- for their internal purposes, we need to have a very robust planning perception execution process. And for their customers, they need very strong R&D from product, sales and services. So the matrix organization was the only way to manage this entire process end to end. To make an analogy, the horizontal teams make sure that they built the road, they maintain the roads and the roads are good to run for vehicles. And the vertical teams are the ones that build cars, maintain the fleet and make sure the cars run smoothly on the road. And these cars are on the well built and maintained roads are responsible for delivering good services and products to our consumers, which forms a very healthy cycle. So we first started piloting this thought in what we call IPD, integrated product development, and the process has actually been validated by the success of L9, L8 and L7, where you might have seen the success of Li ONE, which in a certain view could be a coincidence. But through the application of IPD, we've made that a certainty so that we can replicate the success with our current and ongoing future product development. So we are now in the process of applying our pilot process on a much larger scale to make sure that our company continue to turn out successful products and services to our customers. [Foreign Language] So my first question is about the effect of [indiscernible] in the third quarter, our R&D and selling expense increased to RMB1.8 billion to RMB1.5 billion [indiscernible]. So, you gave a small guidance on next year's expense ratio? And considering that next year, we will have a brand-new BEV platform model on the market and a more complicated and a more channel network layout. So, in addition, in terms of R&D [indiscernible] mainly to our in-house research. This is Johnny. I will take your first question about R&D expenses. This year's R&D expenses will tap as we guided, will be around US$1 billion, which is RMB7 billion for the whole year. It's as expected. And for next year, currently, we see over RMB10 billion to RMB12 billion depending on our final decision on some investments we will start next year in 2024. So, it will be RMB10 billion to RMB12 billion for next year. [Foreign Language] If we look back to 2020, until now, our R&D spending mostly fall into three areas. The first area is product development, which you see similar exercises in traditional car OEMs. The second one is technological platforms, including our EREV platform, our high-voltage BEV platform, our Smart Space platform, autonomous driving platform. These are shared platforms that all of our vehicles use. The platformization allow us to maximize cost or cost efficiency, R&D efficiency and user experience and make sure that they're consistent across all products of our company. The third one is new and fast-growing is our system development, which includes supercomputing, the supercomputing platform, cloud computing platform and our IT infrastructure. These are very long-term but crucial investments for our company. And in terms of organization, the product and technological platforms are run by Mr. Ma Donghui and system development is run by our CTO Xie Yan. And in terms of spending level, we spent the most today in technical platforms followed by product and then thirdly, system infrastructure. And going forward, we expect to see more spending in system and infrastructure, which might eventually overtake technological infrastructure, because we think in the longest term the most crucial investment or a competitive advantage lies in our system and infrastructure capability. [Foreign Language] My second question is about product design and planning. In the family car market segment, how can you exclude with product depreciation in addition to different models such as SUV or MPV and also different number of seats, what can be looking forward to get a greater differentiation? [Foreign Language] Our philosophy is the same as before. We still believe that price and seat configuration is the best way to segment the market. And this has been partly tested by the success of L9 and L7, which is soon to start delivery. In that, these three cars actually have attracted three very different user groups. If you look at L9, it pretty much attracted premium car buyers at the same price point or even higher than the current price level of L9. And L8 pretty perfectly replaced Li ONE and kind of share a very similar customer base as Li ONE. And L7 has been attracting a lot of young family users aged between 25 and 35. So price -- as you can see, pricing and seat arrangements have allowed us to very efficiently cover the market and different user groups and there has even been some surprises in the case of L7, where we've been able to tap into new age groups that we hadn't -- we weren't expecting before. As we are reaching the end of our conference call, I'd like to turn the call back over to the Company for closing remarks. Ms. Janet Zhang, please go ahead. Thank you once again for joining us today. If you have further questions, please feel free to contact Li Alto's Investor Relations team. Then that's all for today. Thank you, and have a good weekend.
EarningCall_1465
Good afternoon. Welcome to cbdMD Inc.'s September 30 Fourth Quarter and Fiscal 2022 Earnings Call and Update. This afternoon, the company issued a press release that provided an overview of its fourth quarter and fiscal year 2022 results, which follows the filing of its annual report on Form 10-K. Today's conference call is being recorded and will be available online along with our earnings press release covering our financial results and non-GAAP presentation, at cbdmd.com in accordance with cbdMD's retention policies. At this time, I would now like to turn the conference over to Ronan Kennedy, the company's Chief Financial Officer and Chief Operating Officer. Ronan, please go ahead. Thank you, Trice, and thank you all for joining the cbdMD's fiscal 2022 earnings call and update. On the call today, we also have Kevin MacDermott, our President and Dr. Sibyl Swift our Vice President of Scientific and Regulatory Affairs. We'd like to remind everyone that various remarks about future expectations, plans and prospects constitute forward-looking statements for purposes of Safe Harbor Provisions under the Private Securities Litigation Reform Act of 1995. cbdMD cautions that these forward-looking statements are subject to risks and uncertainties that may cause our actual results to differ materially from those indicated, including risks described in the company's annual report on Form 10-K for the quarter ending September 30, 2022, and our other filings with the SEC, all of which can be reviewed on the company's website at www.cbdmd.com or on the SEC website at sec.gov. Any forward looking statements made on this conference call speak only as of today's date Thursday, December 15, 2022 and cbdMD does not intend to update any of these forward-looking statements to reflect events or circumstances that would occur after today's date, except as may be required by Federal Securities Law. Thank you, Ronan. Happy Holidays everybody. 2022 was a reset year for cbdMD. We began the year taking aggressive action to rationalize our spend and focus on profitability. We've made a lot of great strides, but it remains a difficult environment for the CBD industry. We spent a lot of time studying the market and consumers and in addition to addressing our cost structure, spent most of the year designing our business to address the following challenges, product efficacy, affordability, and education. CBD is often misunderstood in its impact question. We took this to heart and we wanted to ensure that our brand and products are never questioned for their quality or efficacy. With that imperative in mind, we scrutinized our U.S. product portfolio and launched some of the highest concentration products in the market. This reset resulted in cutting our human product SKUs from over 150 to just over 40. Our emphasis was to be sure that if you take our products that you would feel their impact, so our lineup now features CBD's strengths that range from 1,500 milligrams to 7,500 milligrams. That means if you consume our products, you will feel the benefit of taking properly. We know this through consumer feedback and the results of our two-year long clinical studies. Everyday wellness products were not enough. We knew we could provide consumers more and further differentiate our product portfolio. In October, we completed development of our product design to address the pain management market, for cbdMD MAX. cbdMD MAX provides consumers a naturally derived alternative for pain with the unique combination of cbdMD's proprietary cannabinoid blend and Univestin, a clinically proven natural ingredient with a long legacy of safe human consumption. Pain impacts millions of Americans, we're excited about the product line extensions of channel opportunities that will come with cbdMD MAX. In order to generate growth and attract new customers, it's imperative that our offer is effective, and at a price that consumers can afford as they take CBD as part of the everyday regimen. We expect consumers to take these effective, high-strain products that must be affordable, especially in today's economic climate. We believe our products are some of the most competitively priced products in the category. We expect that our disruptive value will result short term impact to our top line, but as we begin our marketing push at the end of the calendar year 2022 and entering the new calendar year 2023, not only do we expect to attract switches from within the category, with our ongoing educational efforts, the new segmentation initiatives and tailored cohort messaging, we believe we will attract new consumers into the category. We introduced this new highly effective offer pricing in late September. In anticipation of this new product lineup, we discounted our inventory during the summer so as to avoid any significant write-down. That had a compression effect on revenue resulted in consumer stockpiling, elongating our turn cycle. Keeping this in mind, we were intentionally cautious in promoting the new offer to our base of loyal customers heading into the calendar fourth quarter to be sure our messaging coincided with the new demand. Approaching the end of the year as the demand from our base returns, we will begin to heavily promote this new lineup and value proposition expecting to delight our base, track switches from other CBD brands. Our expectations going into calendar 2023 are positive. I'll now speak to our wholesale offers. Our inside sales team, in anticipation of the new product release, got advanced access to the new SKUs and pricing at the end of August and offer them at great introductory rates to offset any pushback from our base of loyal retailers. The new rate card and simplified SKU set has been well received, and we expect that by the end of the calendar year, the approximately 30%-plus compression impact on B2B revenue will be overcome by new added customer relationships in shorter term cycles. Again, we have high expectations for 2023. And through September, our product shipped to over 330,000 domestic retail locations since January. On the grocery front, we entered into a relationship with Wegmans Grocery with five functional SKUs, and these products are currently on the shelves of over 80 stores. This announcement has helped us gain traction in discussions with other grocery chains and big box retailers who had previously been cautious about engaging with the category. Our NSF-certified SKUs helped pave the way for acceptance for our CBD products in Wegmans. NSF product certification guarantees what is on the label is in the product. Achievement of the certification is another way that we at cbdMD demonstrate our leadership and quality products for our customers and will undoubtedly lead to more opportunities in the grocery and big box space. Our category leading NSF for sports certified line is a key component to growth in the sector. We were the first CBD company to commercialize NSF for sport products and remain the only company actively selling NSF for sports CBD products. We believe this line opens the CBD category to a wider customer base than just athletes, including a number of key professions that could benefit tremendously from safe CBD products. By way of expansion, we have operationalized a presence in Japan, standing up systems and support team and began shipping product in late fiscal 2022. We expect this market to expand and other opportunities to opened up during calendar 2023. cbdMD is one of only a handful of companies in the risk assessment phase with the UK Food Standards Agency where our data is actually being analyzed by government authorities. We are currently allowed to sell during the assessment phase with the anticipation being fully approved shortly. In the EU, we believe we are the only company within the risk assessment phase. All companies were put on hold, but we were able to clear that hurdle by providing substantive responses to government authorities and therefore, we believe we have a significant advantage over any other company to be first approved. That being said, we're focusing on our UK supply chain and logistics with the intent to conduct e-commerce at scale. We anticipate some further announcements in the UK during the beginning of the 2023 calendar year. The investment in our safety and sciences allowing us to more effectively communicate to the overall market that cbdMD cannabinoid-based products are a safe alternative for everyday wellness. Our R&D efforts have paved the way to educate, open new channels and partnerships, countries and customers have contributed to a robust pipeline of opportunities that we are developing for you 2023 Thank you, Kevin. On our last call, Kevin said that we have laid the foundation for cbdMD to deliver superior everyday wellness products that are formulated to specifically address the needs of our customers. We have discussed our Citizens Petition to FDA on several of our last call. We began the process in February through our Trade Association, the Natural Products Association, or NPA, and the FDA had until August 22 to respond. As we anticipated, the FDA did not provide a substantive response. And true to form, they stated they needed more time to consider our request. In light of the agency's current approach to regulating dietary ingredients, and my over half decade of experience working at the agency, we believe that now is the time to stand up as an industry and ensure that the agency does not block innovation in the dietary supplement space. While there has been little movement at the federal level towards regulatory clarity for hemp-derived cannabinoid products, states continue to introduce legislation to ensure that consumers have access to safe products that are effective. Maintaining compliance with multiple different state regulations is challenging, but is now a known cost to operate in the cannabinoid space. We are actively engaged with state agencies whenever possible, to present reasonable legislative solutions to ensure that our customers have access to products that support their wellbeing. We are also working with the NPA to directly collaborate with Congress persons and their staff on Capitol Hill to educate them on the challenges that current regulatory regime presents, but more importantly, on the opportunities that responsible legislation and their engagement with the agency would provide to reputable companies like cbdMD and our customers who deserve safe and effective botanically drives wellness solutions at affordable prices. Our novel foods applications are still actively being analyzed as part of the risk assessment phase by the governments in both the UK and EU. We believe we are still the only applicant that has an active risk assessment and not held by EPSA on a clock stop. While other brands including some of our top competitors in the United States, were removed from the market in the UK for marketing products whose THC levels were above the legal limit, our products are still allowed to be legally sold. We will be pursuing similar opportunities in the EU, as we emerge from the risk assessment phase. We currently have 46 products approved and being sold in Costa Rica, with several more plans for submission. We also have five products approved in Ecuador. In Mexico, the Health Ministry, COFEPRIS is currently working through details related to implementing regulations after laws recently passed to legalize cannabis. We are actively engaged with the Health Ministry and have been informed it could take more time. We are not content to wait until the final rules are implemented. And therefore, we have identified a potential white label partner who holds grandfathered permits to manufacture. We're in the final stages of evaluating a partnership to distribute our brand in Mexico. We are excited to announce that the clinical study performed at the University of South Carolina to assess the efficacy of our core broad-spectrum blends in healthy human subjects has completed. Our first set of results demonstrate that our broad-spectrum hemp extract reduces the perception and intensity of pain in healthy adults. The second set of results demonstrated reduced anger and stress in men and women respectively, which led to overall mood improvement. We have also found significant benefits in a number of other key areas that matter to our customers, including immune support and sleep. We expect to publish our findings in a peer-reviewed journal sometime in 2023. Once published, the data from the study will be submitted to the Food and Drug Administration as part of the regulatory submission for a structure function claim notification, which is a process whereby manufacturers and form FDA have their intent to make statements about their products benefits on the structure or function of the body. We firmly believe that our products are not drug precluded, and that we are fully compliant with all applicable dietary supplement regulations. Submitting our regulatory package in support of a structure function claim notification is another way that we demonstrate that we are leaders in the industry. We are advocates for regulatory clarity and fair treatment for our industry and will continue to fight while others choose to sit back and wait. We will pave the way for legal cannabinoid products The data will also be instrumental to guiding our product development roadmap. It confirms that our products will help our customers to support their everyday health and wellness. We will use the data to guide future functional formulas in areas that matter most to our customers. After publishing the data, we will launch marketing campaigns focused on educating our customers on the clinically proven benefits of our core products. We want our customers to understand how our products can help them to achieve their goals. Our formulas pair our clinically proven ingredients with functional ingredients that are also clinically studied and proven to support areas that matter most to them, including sleep, mode and recovery. The data has already guided our recent launch of new flagship products, including tinctures, gummies and soft gels containing the same broad-spectrum blend that was studied in the human clinical. The studies' results will also guide future investigational studies executed by cbdMD's therapeutics division. We are excited to announce the clinical study at Colorado State University explored our core broad-spectrum hemp extracts benefits for dogs in the areas of mobility and active lifestyle is also concluded. cbdMD's broad spectrum hemp extract improved quality of life, as well as measures of pain severity, and pain interference from the canine brief pain inventory scores. On a GAAP basis, total net sales for the fourth quarter of fiscal 2022 were $7.9 million were 19% decrease from prior year's comparative quarter total. For our fiscal year ended September 30, 2022 audited in net sales totaled $35.4 million, a 20% decrease compared to $44.5 million in fiscal 2021. Our quarterly e-commerce direct-to-consumer business generated sales of $6.3 million in the fourth quarter of fiscal 2022. This was a 13% year-over-year quarterly decrease. For fiscal year-end 2022, e-commerce generated $26.4 million of net sales compared to $32.9 million for the comparative prior fiscal year or 19% decrease. E-commerce represented 79% of our total net sales for the fourth quarter, and 75% for the fiscal year-ended 2022. Our wholesale business generated $1.6 million of net sales for the fourth quarter of fiscal 2022, down 37% compared to $2.5 million for the comparative quarter in fiscal 2021. Kevin previously mentioned our sell-through strategy prior to our transition to our higher strains offering, this had a large impact -- larger impact on our wholesale business as we transitionally offering and had sold several products out of stock prior to the reset. For the fiscal year-ended September 30, 2022 and 2021, our wholesale business generated net sales of $8.9 million $11.6 million respectively. Product sales totaled $3.7 million for 2022. Our GAAP gross profit as a percentage of net sales came in at 64% for the fourth quarter of fiscal 2022, this compares to 58% for the comparative prior year period. For the fiscal year-ended September 30, 2022 and 2021, gross profit was 63% and 67% respectively, as a percent of total net sales. We expect to maintain gross profit margins in the mid-60s when factoring in the sales mix. Our operating expenses for the fourth quarter fiscal 2022 totaled $7.9 million, beating the $8 million target we provide in our last call and which was down from $12.7 million as compared to the prior year period. Operating expenses decreased 38% from the prior fiscal year, mainly due to sizable cost reductions across all areas of our business. For the fiscal year-ended September 30, 2022, operating expenses decreased to $39.5 million from $49.6 million in 2021. This decrease is mainly due to reductions across all areas of our operating expenses, that was partially offset from an $884,000 non-cash intangible expense as we gained amortizing intangibles during the fiscal year. Overall, this resulted in a GAAP loss from operations of approximately $14.8 million for the fourth quarter of fiscal 2022, as compared to $7 million loss from the prior year period. Excluding the $11.9 million goodwill impairment our non-GAAP loss from operations totaled $2.9 million or $5.1 million improvement over the prior year. Sequentially operating income declined slightly from the June 2022 quarter to the fourth quarter of 2021. This is primarily attributed to $1.4 million drop in gross profit while achieving $1.1 million in net cost savings reduction, mostly from marketing and payroll expenses. For the fiscal year-ended September 30, 2022, and 2021 our GAAP loss from operations totaled $78.1 million and $19.6 million respectively. Excluding the $60.9 million of goodwill and intangible impairment our non-GAAP loss from operations improved to $17.2 million a $2.4 million year-over-year improvements despite the drop in revenue. Our non-GAAP adjustments to operating expenses for the fourth quarter of fiscal 2022, include a $275,000 non-cash stock expense, $456,000 depreciation and amortization and $11.9 million of goodwill impairment resulting in a non-GAAP adjusted operating loss of $2.1 million for the fourth quarter of fiscal 2022 as compared to a $4.7 million non-GAAP adjusted operating loss in the fourth quarter of fiscal 2021. The decrease in the non-GAAP adjusted operating loss over the prior year period is primarily attributed to management's focus on our cost structure and profitability. Sequentially, we reduced our non-GAAP adjusted operating loss by $0.6 million from the June '22 quarter to September '22 quarter. We now have five consecutive quarters of improvement in our non-GAAP adjusted operating loss. For fiscal 2022, our non-GAAP adjusted operating loss totaled $13.1 million and represents a $0.5 million improvements in the prior year despite the significant drop in revenue. We invested $565,000 in cbdMD Therapeutics' R&D during fiscal 2022 as compared to $650,000 in 2021. Much of this was front-loaded in the year, but we are now reaping some of the benefits through the clinical results Sibyl mentioned earlier. We believe this will provide a unique differentiated position for both product efficacy and education in the category. Other Income expenses in our consolidate income statement for fiscal 2022 include a $0.25 million gain related to the sale of assets early in the year, in addition to a non-cash contingent liability gain of $8.5 million related to our December 2018 acquisition of Cure Based Development. The earnout contingent liability is currently on our balance sheet at $276,000. We're now in the fourth marking period that runs through November 2023. During the fourth quarter -- of fiscal quarter of 2022, we utilized approximately $2.8 million of cash. The main components of this included our adjusted non-GAAP operating loss of $2.1 million paid dividends of $1 million with some working capital adjustments making up the difference. We had cash and cash equivalents of $6.7 million and working capital of approximately $10.7 million on September 30, 2022, compared to cash and cash equivalents of approximately $26.4 million and working capital of approximately $29.6 million as of September 30, 2021. The current assets as of September 30, 2022 decreased approximately 56% from September 30, 2021 to $16 million. The primary driver of the decrease in current assets was the usage of cash for our operations. For the September 30, the company's total current liabilities were $5.2 million, of which approximately $2 million is accounts payable and $2 million accrued expenses. As our audited, consolidated financial statements for the fiscal year-ended September 30, 2022 containing audit opinion from an independent registered public accounting firm and including an excellent [indiscernible] paragraph related to our ability to continue as a growing concern. We remain very focused on managing our cash position and liquidity. We continue to address our cost structure to improve our bar. We optimistic about a competitive product position, and cautiously optimistic about our ability to grow quarterly sales in calendar 2023. With our current SG&A, a small increase to revenue will have a big impact to the bottom line. We are pursuing multiple avenues to improve our liquidity, while being mindful to our existing shareholders. Adara has filed their proxy vote, and assuming it receives the votes and anticipates closing their transaction in January which will return our $1 million investment. We're in the process of filing for an employer retention credit, and pursuing several strategic partnerships and other avenues that could either reduce our burn, accelerate profitability or improve our liquidity position in 2023. As Kevin mentioned, we truly have a unique and compelling product offering that allows customers to benefit from its efficacy without breaking the bank. Thank you, Kevin. We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Richard Molinsky [ph], a private investor. Please go ahead. Hi, guys, how you doing? Congratulations. And I love the product -- I love the product as you know. You mentioned about this $1 million payment that you're going to receive in January, you were mentioning. Can you just explain that a little bit further to me if you don't mind? And I have one more question after that. Sure. So we previously had invested $1 million in the Adara stack that's been sitting on our balance sheet. And our last -- all we -- as part of sort of the situation that happened, ended up signing new agreement to receive the capital back upon a closure of that transaction. So that transaction has been moving forward. They filed the sort of final proxy to prove the merger, so I think most parties are assuming that that is likely going to happen. At that time that we would get our capital back. Okay. So with that capital, and a plan, which you've been on, which is to get to profitability. And I know, I've asked you this before. But my hope is that we don't have to go back to the equity markets, you could do some strategically or get to the profitability, $1 million dollars definitely going to help. But is there anything you could talk about? Will this be enough money do you think to see whether you are executing or there could be something else to talk about that would maybe help the finance structure? Look, Richard, we're looking at a lot of different alternatives right now. So it can't be anything specific. But we got a lot of things in the works. [Operator Instructions] As there are no further questions from the phone lines, this concludes the Q&A session and today's conference call. You may disconnect your lines. Thank you for participating. And have a pleasant day.
EarningCall_1466
At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require Operator assistance during this conference, please press star, zero on your telephone keypad. Please note this conference is being recorded. I will now turn the conference over to your host, Mr. Mark Harding, President and CEO of Pure Cycle. You may begin. Thank you Jenny. Good morning everyone. I’d like to welcome you to our first quarter earnings call for our fiscal year 2023, and happy new year to you all. We have a slide deck for this. If you can surf over to our website at purecyclewater.com on the landing page, you’ll find a button on there where you can click on that and then we will actually forward through the slides, but it will give you the ability to see some of the text in the slides within the presentation. With that, I’m also joined today this morning by Kevin McNeill, our CFO, and Dirk Lashnits, our Vice President and Director of Land Development, who will also give you updates into some of the business segments and the financial reportings, and then at the end we’ll have a brief Q&A for those of you who want to drill down on some of the specifics. With that, let me first start with our Safe Harbor statement, which I’m sure most of you are familiar with. Statements that are not historical facts that are contained or incorporated by reference in this presentation are forward-looking statements. With that, we’ll get the lawyers out of the room and we’ll start. I’ll just be very brief on some of the overview of the company, but for those of you that are first-timers to the call or new to the company, we really operate on three primary business segments, really that are fundamentally interconnected to each other at the DNA level of the company. We’re a water-wastewater utility company, where we own water in a water-short region here in the State of Colorado and the west. We develop those water rights and we are cradle-to-grave on the water rights, where we develop the wells, the distribution system, put that water to use in both the land segment, which is a parcel of property that we own that we’re doing a master planned community on and we’re building lots for our homebuilder customers, and then we are holding back some of those lots and building homes on those for the single-family rental segment as well, so each of those segments really are interrelated to a vertically integrated platform that we have from the water utility side. Moving on to just describe a little bit briefly about the water segment itself, we have just that whole network of utility operations, where we have the diversions for the water supply, whether those are taking water sources from our streams and surface water supplies, our groundwater supplies or our reuse supplies. We treat that water, we store it, we distribute that out to our customers. We’re also responsible for some of the development of that distribution system pursuant to our design standards for our community, which is some of the lands that we have but others as well, so we have master planned service areas that are very valuable, which we will highlight a little bit later in the presentation. Our customers use that water, they give it back to us, we collect that, we treat it and then we reuse it, so we have a use and reuse model. Within that, we get some fee instruments for that on the water utility side. We get connection charges, which are a one-time connection fee which, between the water and the sewer tap fee, are around $32,000, $33,000, and those are paid by the homebuilder, our homebuilder customers, and those are typically added into the cost of the home, but that grants the service connection a permanent entitlement to the water supply and then we get usage fees for that, so we get a base fee which really amortizes some of the cost of operating and maintaining a system, and then a consumption charge which is a tiered consumption charge, and so what this tends to do is it tries to encourage conservation, because the more water you use, the more water--the higher the cost of the water supply. As you take a look at our water balance, what we look to do is really keep control over that drop of water, where we’re taking that from the supply, we’re treating it, we’re putting it into our system, we’re getting it back from our system, and then we’re reusing that, and so we do have a very closed loop system. We do lose a little bit to outdoor irrigation and some evaporation, but those trends are really decreasing and there’s been a lot of press, I’m sure much of you have seen, about drought and the vulnerabilities of water supply on the left, so the company’s emphasis on technology and controlling that drop of water through its continuous life cycle is very important to our systems, and we want to make sure that we’re good stewards of this water supply. Taking a little bit of the infrastructure, you know, we build this infrastructure. It’s long-lived assets. The water supplies certainly are long-lived - those are perpetual, and then you have a lot of the brick and mortar that we’re building associated with that, and really this is showing the growth of the company in the last five or six years, really showing about an 86% growth in the capitalized asset class and the various categories of that infrastructure, whether that’s water and wastewater treatment facilities, transmission lines, wells, finished water storage, surface water, groundwater supplies, distribution systems, all the components of a water utility you’ll find in there, so that will continue to grow as we keep seeing that. Moving into how the growth of the utility looks like, our current customer count is up to about 1,250 new connections. We measure that in terms of the number of single family equivalent connections on it, and so we have a combination of residential customers which would be a standard single family equivalent, but then we also have commercial and irrigation connections attributable to those, and so just because you might have one irrigation connection, that might represent as many as a couple hundred as you see down in Lowry, because we have large irrigation requirements down there of connections. We rate that to the number of how we build those out, so the number of base charges that we get for each of those. I talked a little bit about our residential connections at Sky Ranch, which is our development. We have our first phase, which is completely built out, 500 homes. We are into our second phase, very robust tap sales in our second phase - Dirk will drill down into that a little bit, but we’ve got 124 taps there, and then a service area that we picked up a couple of years back, where we have more than 200 connections between the residential and the commercial connections as well. Moving on, another one of our big customers on the utility side is the industrial space, where we sell a lot of water to the oil and gas industry through a number of different operators. Our water supply, our service areas, and really--you know, the City of Colorado is located over a fairly prolific oil and gas field that’s gotten a little bit more attention more recently with the shale oil play, but we are seeing operators drill a number of pads in a number of formations here that consume a tremendous amount of water for oil and gas, and so we continue to see those sales. This is the distribution of how those sales go by quarter, and as you can see, it’s kind of all over the map. There’s not a lot of predictability to it. They drill year round, they frac year round, and a lot of this is really dependent on a permitting process and how aggressive they are. The leasehold interest particularly in our particular field has changed hands a number of times, which is pretty typical in the oil and gas industry, but it started out probably in 2015, ’16 time frame with a lot of the field assessment and field definition, and now it’s kind of moved into more of a well development, so they’re developing the field, so they don’t do a lot of exploration, they don’t do a lot of changing to it. Each rig has a much stronger capacity to drill more wells per pad per year, and so what we’re seeing is when you get a dedicated rig out here, that can drill as much as 25 to 30 wells a year. They’re pretty significant wells. They’re two mile lateral wells on this thing. I think they’re experimenting with some three-mile lateral wells on it, and so they’ll continue to increase the amount of water that they’re using, depending on their laterals on it. This is kind of an illustration, if you look at the right-hand side of this, that will be kind of the Denver metropolitan area and kind of the growth of the metropolitan area. The two red areas or pink areas that you see in there, those are service areas. If you look at the one, kind of transition between the green and the grey there, that’s our Sky Ranch project, which is ideally located - it’s on the I-70 corridor, and it really is in the strongest area of growth in the Denver metropolitan area, and we as a developer are really targeting the entry level housing product, which I think inures very well for us both in very strong markets as well as in challenging markets, and so Dirk will talk a little bit more about that. Then our service area at Lowry, it’s the very large pink area which continues to be really an untapped asset for us. The land is owned by the State of Colorado in trust for the public education system here, and it’s one of the most unique assemblages of land in the country. As you can see by the picture on the left there, most of the development has really come up to the border of that property, and so it depends on how the state looks to move forward with that, but that’s certainly an opportunity for us over the next few years that we look forward to doing the utilities for that. We’re the exclusive water-wastewater provider for that 24,000 acres of continuous property. That gives you kind of a sense of the utility side and some of the segments that we have in there. I’m going to hand this off to Dirk Lashnits, who will talk a little bit about our land development activities. Thanks Mark, good morning. Land development - so here’s our flagship project, called the Sky Ranch. Every time I see it, it’s overall view, it always reminds me of the dreaded Tetris piece from that game. This is 930 acres, like Mark said, on the developing edge of development out on the east side of Denver. It has 3,200 residential lot capacity and 2 million square feet of commercial capacity, and we’re about 15 miles east of downtown Denver. Sky Ranch has probably got about a 10 to 15-year build-out that will be heavily dependent on our market conditions. We’re going to build this out in multiple phases. Over the last probably four or five years, you’ve heard us talk a lot about our first phase - that’s the first 500 lots, that’s pretty much in the books, and we’re now moving onto our second phase. That first phase is the block on the left side of the picture, and then our second phase is kind of the middle portion of the parcel, and then future phases will grow out to the east, and our commercial piece is the northern block adjacent to I-70. We plan to build about on average, probably about 250 lots per year out here, and we’ll layer in our schools and commercial pieces and rec centers, all those things that go along with a master planned community. Phasing--as I mentioned, Phase 1 in the books, that was 500 lots. We also had our pilot program for our build-to-rent lots, so we had four occupied units in that phase, 100% complete. Then moving into our second phase, this is 850 lots. We’re sub-dividing this into four sub-phases - that’s 2A through 2D. We are well underway in our Phase 2A - that’s about 80% complete, and we’ll have that completed later this year, beginning of 2024. We’ve started our infrastructure for Phase 2B. We’re hoping to start that in earnest quarters two through four of this year, and then the third and fourth sub-phases, 2C to 2D, we’ll build out in subsequent years. Our Phase 2A, we just had our first few residents move in there, so that’s exciting. We have delivered all our lots to the builder customers there. As you saw by our water taps number on the previous slides, those are indicative of the number of homes that the builders have started, so we’re right about that 120, 130 houses started. I think the builders have sold probably about 20, 25% of their lots, and they’ll look to have those sold out the remainder of this calendar year, and then we’ll be looking to have that second phase come online for the next batch of lots to not interrupt that sales cycle. All right, so this is the details on the phasing. These are--this is the Phase 2, 850 lots broken down into the four sub-phases. We’ve got our lot revenues - those numbers are what we--our income from sales of the lots to the builders, and we have our tap revenues, those are the water and sewer connection components that Mark mentioned. Then we have our costs to develop the lots and then we have our reimbursable component, and those are the costs attributable to public infrastructure that are eligible for receivable reimbursement through public dollars, whether that’s taxes or bonding. The graphs on the bottom of the sheet here, the bar graph and then the far right pie chart those are our builder breakdown, builder distribution. We have our four builders in this phase, and that’s by builder, and then our--that center pie chart is our product mix, so those six slices of that pie represent our--the different product market, product segmentation which we think is a good balance of product offerings and good diversity. Moving onto some market conditions here, sort of the news of the day, start with our--the good, so the positive things. The pent-up demand for new home sales, we think there’s good upside here. Back in the ’05 - ’06 time frame, there was about 1.4 million in home sales, and even in this latest upswing in ’01 - ’02--or ’21, ’22, we’re only at 600,000, so I think that represents good upside for us. In that first quarter, we’ve seen the mortgage rates start to stabilize. They’re kind of hovering around 6%, and that’s in historical norms. Lot delivery is still trailing home starts, so in other words, we are still selling more homes than we are delivering finished lots, so from our standpoint, being in the business of selling lots, that’s good potential there, like to see that, that demand. We’ve got--our homebuilders in Sky Ranch are all ranked nationally. All four in the second phase are in the top 15, I think three of them are in the top 10, two of them are in the top five, so that’s-- Yes, the top one, top two even. Good for stability and in it for the long haul. They’ve certainly seen some of the market swings and are good partners in helping mitigate that. Low unemployment, this is obviously a really important one, we hope that stays positive. House prices still appreciating by now, still a good investment. Lower average days on the market - houses are still selling pretty quickly and those are some typical numbers there. Last year, we were down--in Denver at least, we were under 10 days on average, and houses were selling above asking price sight unseen, day of asking. A year ago, we had that peak and even today with some of the slowdown, we’re still seeing, based on market, in the 20s, so that’s all still good outlook. Onto the bad, or opportunities that we have here, again the abrupt uptick in interest rates kind of shocked the system, and I think we’re slowly adjusting to that. Again, we’re still in kind of historical norms. A lot of the important metrics still trending downward - builder confidence is down, applications for mortgages are down, buyer traffic in the model homes is down, home sales are all down, and then combine that with higher material and labor costs and then our cancellations on contracts are still up. You know, I do think at the end of the day for us, houses are too costly. We need to figure out ways to recalibrate that. The land development side that we do is a link in that chain and how do we adjust for those changing markets, and the way we do that is mostly on a timing--from a timing standpoint, and that’s really our challenge, is trying to time our deliveries. We have a long lead time in the development business. We’re probably anywhere from at the earliest six months, but more likely a year out from when that demand comes online, so we have that challenge on trying to find the right time to build our lots. Here is just a slide, it’s a couple of the--it touches on the job growth chart, interest rates and some sales information. I’m going to push this over to Kevin and he’ll give you an update on some of the rental segment, and also just some brief stats on the quarterly performance. Thanks Mark, thanks Dirk. Yes, so our single family rental, our newest division that we launched in 2021, we continued growing it. We’re up to--we’ve got four houses completed now as of December 15. We’ve got 10 more under construction, and those will be delivered throughout the year, throughout our fiscal 2023. The four that are rented are all rented from $2,800 a month to $3,000 a month, pretty stable renters, we think, so still very optimistic about this market. With this new segment, especially with interest rates continuing to climb, with home values continuing to stay high and the slowing of that market, the rental rate market in Colorado especially is going to be very strong. This is some projections that we put together using our fiscal year from last year, our 2022 results, just because the first quarter is a smaller piece to look at. We’ve projected out with 14 home and 50 homes. Fifty would be the entire Phase 2, 46 homes there and four homes in Phase 1. What you see is our current projections, obviously depending on cost and interest rates and everything else, is about a million dollars a year, just short of a million dollars a year in free cash flows from operations of just the rental units. It doesn’t include obviously overhead or anything like that, but--. The financial results for the quarter, it wasn’t the strongest quarter we’ve obviously had. There was, from a water-wastewater standpoint, as Mark touched on earlier, we continue to invest in the water infrastructure, a little over $67 million now in water rights, which we can pass that water rights themselves and supply infrastructure to bring the water to our customers. We delivered about 67 million gallons this quarter, which is down a little bit from last year, which is predominantly down because there wasn’t a lot of oil and gas activity during the quarter, and also construction activity was down, so the Phase 2A being done and 2B not really started yet, we didn’t sell as much water to construction activities. Dirk obviously touched on the land development side, which you’ll see when we get to the balance sheet and income statement as well, and then single family rentals continued to grow. From a graph standpoint, you can see obviously the revenue and segment revenues were down for this quarter compared to each of the last few quarters. One thing I’ll point out is in that Q1 2020 quarter, that was kind of an anomaly. We recognized a bunch of revenue in that year to catch up some contingencies that we had, and also there was a big--there was a lot of lot sales that year. Phase 1 was going very strong, Phase 2A was getting ready to start, and so it was just a--it was a great year. This year, you’ll see the revenues are down, predominantly again because we talked about the housing market slowdown. We delayed a little bit of Phase 2B in order to match our lot availabilities with their--with the homebuilders’ sales, so that was somewhat intentional, but obviously with the housing market and interest rates, that was hard to control. From a net income standpoint, you’re going to see the same thing, that income dropped during the first quarter compared to the other quarters - same reason, revenues were down. We were able to offset some of the revenue declines with a little over a million dollars in surface use and other payments from oil and gas companies, which we think is a pretty strong indicator of a good 2023, we hope, for fracking and drilling, and continuing out throughout the rest of the year throughout our service area, and then obviously there’s our diluted earnings per share. There will be a little more information on this coming out when we actually file the Form 10-Q, which we’ll do in about four or five years, which we anticipate filing here in the next few days. A few upcoming dates - we have our annual shareholders meeting tomorrow, which is--you know, there won’t be any big presentations, it’s more a formality, so not expecting a big event for that. Our 10-Q, like I said, the filing date is January 17, but we file before then, and then if you haven’t seen it, our ESG report, we launched in November so that’s on our website, gives you a little more detail into our--what we’re doing from an environmental standpoint, how we’re trying to be good stewards of the environment and our money and the shareholder money. Real quickly, the balance sheet and income statement, you can see we had a pretty good pick-up in cash last year. The Sky Ranch cap did a bond offering and was able to repay a little over $24 million in total to us of reimbursables, and so we invested that in some short term treasuries and capitalized on some of those interest rates, continued to grow the balance sheet in terms of assets, and investing in new water rights and infrastructure. You’ll see the income statement, obviously I won’t spend a lot of time here, but it will come out in the Q, and then the press release we issued last night has a lot more information on it, but you can see the revenue decline that we discussed predominantly in the land development, lot sale area in that commercial water sale area. Our overhead stayed fairly consistent - you know, we’re keeping our headcount strong, and then you can see in that other net, the $1.2 million of other income, that was basically surface use payments and future--in anticipation of future drilling and oil and gas operations on our land. Thank you. Okay, so what are our takeaways here? I guess takeaways for management would be the stewardship of how we handle our business model. We’ve got very valuable, very low cost basis legacy assets here, both in terms of the water and the land side of the equation, and what we’ve done successfully is really make sure that we carefully position you all with your invested capital to market exposures, and so one of the ways that we do that is through how we handle our builder contracts, and those of you that are familiar with the company kind of had this appreciation, but we have a lot delivery agreement structure where our builders are working in partnership with us on delivery of this very expensive infrastructure, when you’re in a high cost business where we’re delivering horizontal infrastructure for master planned communities and then the housing side of it, the vertical side is handled by the homebuilders. But that infrastructure is very expensive, and we want to make sure that neither we nor the builders, our builder partners have too much exposures in softer markets, and we’re in a softer market right now. Really, the validation of that business model is the fact that we don’t have any exposure in there, right? As you saw in the presentation and Dirk highlighted, we’ve got about 15% of the Phase 2B, which really would be the grading and the over-excavation components of that, that we’ve invested in, and that’s been covered by our homebuilder customers, so that’s not a significant investment in there. Then as their lot deliveries, and this is about pace, right - this is about how many lots they want to have in inventory because they want to match their sales cycle, and maybe in Phase 1, each builder was doing seven to eight homes a month, so that absorption was pretty high. In Phase 2B, we’re seeing maybe three, but we are still seeing that and it’s three homes per builder, so that gives you a cycle for that. We find ourselves in the right market segment, that entry level product, and so as the homebuilders come out there and look for buying opportunities, Dirk really highlighted the continued demand for single family homes in the marketplace, and that’s still--we’re seeing that in the marketplace, we’re seeing that in terms of the builders and the building permits that they’re pulling and the spec homes that they’re building out of Sky Ranch, and then also that they’ve having sales, you know, that we’ve got customers that have moved out there in the last 30 days and continuing to really see that absorption. We continue to inject value into the community. We’re opening up our school, which is going to be a tremendous asset for them because it’s a local school, a charter school that we’ve partnered with a national charter operator out of Michigan - National Heritage Academy, and they have a website, the Sky Ranch Academy has a website. You can take a look at that, but really good delivery device for education for new families out there. Then taking a look at kind of diversity, one of the things that we like and Kevin mentioned was single family rental business. There’s still a ton of demand for more space at your home because of the work balance, the work-from-home balance. You’re seeing a lot more dual income families looking for more space so that they can have offices at home, and our home product--you know, we’ve diversified from either a 45-foot lot or a 45-foot lot in Phase 1A, and now we’ve got six different product categories, and that’s inuring very well to the market segment. You have six different price points in there as opposed to just a couple of price points, depending on finishes, so a lot of those design features that we had in our master planned community really is inuring well and will stand the test in both good markets as well as headwind markets. Then ultimately continued sales of water in industrial operations, so we’re going to see a little bit of uptick in oil and gas demand, but that’s really a steady-eddy customer for us. We like making sure that we supply that segment water supply and then can convert that water supply over into the potable supply, so there’s a really good balance in how we’re extending and developing into these assets. Then continued growth - you know, we continue to grow the company, small tuck-in acquisitions of assets. As you’ve heard me talk about in prior acquisitions, we’re on the hunt for more land and to really kind of build our land portfolio. Don’t have anything really substantive to talk, so I’m going to forecheck some of your questions on what’s the update on acquisitions for land development. There are a number of opportunities that we’re pursuing and we’re very aggressive about doing that. One of the nice things we have is we can be aggressive about that - you know, we have a very liquid balance sheet. We’ve managed this capital well, we’ve been disciplined with our board to be making those investments and then also making investments in ourselves with the stock buyback, so those are kind of the capital allocation structures for us. So with that, I’m going to turn it over to the lovely Jenny in Scotland, who is waiting for her lunch, and see if there’s any questions that you might have on drilling down some of the detail. I just had a--hi, I just had a quick question on the--for the new customers that are getting added on. You talked about $1,500 of annual revenue from the water customers when they come on. I was just wondering, at least maybe at Sky Ranch, as you’re adding customers, how much additional costs might there be? Are the--you know, is the infrastructure and kind of everything in place so that $1,500 is really kind of almost all incremental, or is there additional costs that kind of get layered on as you’re still kind of building up stuff, or have you kind of reached a critical mass when maybe the costs are decreasing a lot slower than they were earlier in the project? That’s a good question, and really we segment some of that brick and mortar cost for adding those connections into the tap fee charges. Typically, the way we see it is that the connection charges, that $33,000 for a tap fee charge, we build the wells, the treatment facilities, all of the brick and mortar stuff that delivers that water to the customer through that capital allocation base, and a lot of that is sub--is early on investment that we’ve had, and then also what we see is the oil and gas revenues tend to allow us to expand that system apart from the tap. The way we usually look at is that’s a 50% margin business, but it becomes a little bit better margins because some of the oil and gas revenue, we can allocate to expanding that supply side in advance of those tap connections. When we get the actual connections, the $1,500 connection per year which is really your point, there are additional costs in that because we have an operating entity where we’ve got chemical costs to make sure that we disinfect the water, we have lab costs because we have to continuously sample our water and make sure that our water meets all of the primary and secondary clean water standards, so that business we typically also look at as a 50% business, 50% margin business, and it’s not so much on the capital side as it is on the operating side. We have operators that are making sure that they’re going out, making sure the system is operating correctly, taking a look at whatever’s occurring daily, nightly, weekly on those sorts of things, in addition to really the lab costs. That’s how that divides out. There’s not a significant uptick in that - as a matter of fact, it’s usually a little bit better on the front end because everything is brand new and it operates the way it’s supposed to. But we really--we look at those margins as about those 50% in each segment of that, if that answers your question. Yes, sure. Then just that $1,500 number, I think you guys have kind of been talking about that for a number of years. Is there pressure on that, or I don’t know, is the market rate elsewhere in Denver, are other people charging that amount, or is there possible pressure for that going up, just inflation in general? How are you able to kind of keep the customer rates flat? Yes, and I would say there’s two rates there. There’d be the tap fee rate and then the usage rate. The tap fee rate probably has a little bit more upward mobility just because of the scarcity value, and as you continue to hear about the competitiveness of water rights and the incremental costs, because we have to go farther and farther out to reach for those water supplies, I’d say our tap fees have a little higher upside than, say, necessarily usage rates. The usage rates will continue to grow. We continue to grow those for making sure that we keep up with our inflation costs as well as anticipatory costs for whatever the evolving regulatory climate is going to look like, but that’s a little bit more inflation-oriented as opposed to the value of water in water short areas and the cost of water, acquiring those water rights from farther and farther areas. When you take a look at those two revenue streams, there’s probably a little more strength in the tap fee side, which is going to be our big number. You apply that to our portfolio - we have 60,000 connection worth of that, so that’s over $2 billion worth of revenue potential over time as opposed to that $1,500. That’s been a stagnant number. We’re probably a little bit above that - that’s just been a metric number that we continue to look at. I would say that that continues to go at about 3%, 3.5% per year. Thank you very much. Your next question is coming from Bill Cunningham, who is a private investor. Bill, your line is live. Good. You know, on the last conference call, I had made the comment about the unusually good results, which were a result of lot sales and tap fees, and we talked about how earnings are lumpy so we might not see the same results quarter to quarter, and this quarter proved exactly what you were talking about. I kind of did some penciling out of things ahead of time to kind of figure out what your numbers might be and thought it was 50/50 as to whether you’d be reporting a loss or a profit this quarter, so it was kind of a pleasant surprise that you actually squeaked through with a bit of a profit. Hopefully nobody else was surprised with the results being not as good as the prior quarter. No, that’s true, Bill. You know, it’s cyclical in a couple of ways. One, because of the way our year-end reports, that puts us into--and where we report, right? I mean, Denver, as most of you all found out, Denver’s a great place to live except maybe December-January-February, so cyclically we have--and we’re in the outdoor business, right, so a lot of our water supplies, outdoor irrigation, outdoor land development activities, outdoor sales for single family homes are all cyclical in the winter months. It is pretty predictable. We are grateful that we were still able to be profitable, and we will continue to strive to do that quarter over quarter. I do have a couple of particular questions for you. One is I was looking at the tap fees sold in the totals - your 10-K at August 31 said that 618 taps had been sold in Sky Ranch. Your press release said four more were sold this quarter, but then you reported a total of 766 taps that have been sold so far in Sky Ranch, so I’m confused on the difference between the 766 and the 622. Yes, and really what we--and this was a real strong push to normalize the number of tap connections. There’s a difference between the residential connections, and then we have the CAB, the governmental entity that’s responsible for the parks and the open space and the outdoor irrigation, and they pay a tap fee but they’re only connection, and so that’s the difference. What you’ll see is when we report the number of irrigation connections, that’s a higher number, and so--and we’ve been really trying to normalize that for everybody so that people like you, who really drill down into the numbers, can get a feel for that $1,500 per connection per year amount, what is that applying to. That’s--now we’re really trying to give you all a little more clarity, is this applying that to 1,246 number of connections. When we send out a bill, that’s not 1,246 bills because there may be one customer that might have 50 of those connections, but that equates out to the same number of connections, so that’s what we’ve tried to--I was figuring, would I do that statistic this quarter? I’m like, Cunningham is going to call me out on this thing! So I’m glad you did, I appreciate that, but we did that with you in mind specifically, for the detail orientation as well as Robert, who came back and said, okay, I’m really tracking this $1,500 per connection. We really want to give the market a better, clearer understanding of how to compute that number. Then also, I have some questions on the different builders in Phase 2A. There seems to be a big difference from builder to builder as to what they’re doing there. I mean, KB looks like they’re going gangbusters, where they’ve sold 27 homes already, which I think is about two-thirds of their total, and Challenger with their homes seems to be doing okay also. Lennar has just started selling their single family homes, but their townhomes are still listed as coming soon-- --and then D.R. Horton, we had talked about last quarter, where I guess they were having to do some revisions to their building plans with the County and hadn’t started yet, so I’m just wondering what might be going on with a couple of the laggards here with Lennar townhomes and the D.R. Horton homes. You know, those are the two largest builders that Dirk was referring to, and I’d say they all kind of look at their own scheduling and this is new for both of those builders. This is kind of a new project that they’re in, and I think Lennar has got--they’ve probably got--of their townhomes, they’ve probably got 18 spec townhomes under construction, so what they’re really--more Lennar than D.R. Horton, are really pushing for the seasonal downtime where they can build and then hit the market in kind of the March cycle with a ton of product. They like the product that they have because it’s very price-sensitive product. Those townhome products are going to do extremely well, and I think what Lennar’s forecasting is we want to have a good inventory of those. I think we showed some aerials of that, and if we didn’t do it in the earnings presentation, jump on the website because we throw up a lot of our drone shots on that. You can see the bulk of the starts and the numbers out there, and I think we’ve got more than maybe 60, close to 70 vertical construction out there, of homes out there, and you’re right - KB’s done very well out there because they’ve got a paired product. Again, that’s higher density, better price points out there. Challenger is very competitive on the price, and then Horton--you know, they’re pulling lots of taps, so we know that they’ve got lots of building permits that they’ve got teed up, and then they’re just going to line build. They’re just going to throw everything they’ve got at it, do it all at once, and they’re pretty stylistic for the builders, each of [indiscernible]. Wow, okay. That’s great, because when you look at the website and see Coming Soon, you just figure that nothing has happened yet, so-- Happy new year. I wonder where we are with two things: one, you at one time indicated you might buy back some of the lots for the build-to-rent part of your business; and secondly, where do we think we are with the I-70 development, which can either be sometime near term, and I wondered whether you could give us any indication of how soon that might take place. In terms of the buyback and some of the other phases of the lots, we’re moving forward with Phase 2B, we’re recording our plat this month, and then we’ll get a sense from the builders. I think the builders were really hoping to wait to see how their traffic activity was going to look for the first part of the year, and so we’ve reached out to each of them and let them know, you know, as you look to your close, if you have--if your absorptions extend yourselves out a little bit farther than you would otherwise want to inventory, we will pull whatever number of lots back from that. All four of our builders have that offer, we’ve made that offer to them. They’re all under contract, so I’ve got to work with them on their cooperation, but I’m pretty confident we’re going to claw back--not claw back, we’re going to be invited back in a couple of those from some of the builders, because it’s a win-win for them. They can not close on that lot and then we’re talking with them specifically to say, but you can still build the house on that. That’s an opportunity for them not to have to--it really is a win-win, right? They can manage their cash flows so that they actually can still show positive sales on Sky Ranch to a customer that they know and they understand, which would be us, as opposed to waiting for traffic and contracts and cancellations. This is a great opportunity for both us and them to really continue to build the portfolio, and we’re seeing extremely strong demand. Every time we finish one of these houses and we put it up, it is gobbled up. We put it out on Zillo and it’s just--you know, we get competitive people looking for rental on this stuff, so we still are very aggressive. We still like that segment, we’re moving forward into that segment. The question would be, well, can we do more in another phase, get out of the 850 and start another phase? We can, but that puts us in a bit more exposure, where we’re actually inventorying all those land development opportunities, and we do have a balance sheet that can do that but at the end of the day, we’re also balancing that against opportunities for acquiring other land and making sure that we continue to build and grow the company, so there is balance there. Second question in terms of the land development side on the I-70 corridor, I think you’re probably referring to the Lowry project, and we continue to see a lot of pressure for entitlements. Everybody wanted more and more finished lots in the marketplace up through what was this interest rate environment, and us being able to time the market, where we’re delivering lots, not throwing 850 lots to builders for them to inventory but doing this on a cyclical basis, where they’re helping us pay for that hold cost as well, certainly is a proven delivery model for land development. We’ll see with the weakening of housing how that cycle comes into impact Lowry’s timing and other land development in and around Sky Ranch that we’re also looking at acquiring, so we’re cognizant of all those elements. Our crystal ball isn’t any clearer than the market, probably even cloudier than some of the experts in the market, but what we try to do is make sure that we’re making informed decisions with our capital allocation plan. That’s a great opportunity for us, and if the market continues to frustrate that stock price, we’re there now. We’re ready to do that. Do I have an answer for you at what price do we buy stock? I don’t. Okay, we have now reached the end of the question and answer session. I will now hand back over to Mark for any closing comments. So in closing, I guess I want to continue to thank you all for your continued support and confidence in our business, our business model and our team here. I want to recognize and give a shout-out to our board of directors - they’re an outstanding group of folks that continue to give our management team very sound and reasoned and expert advice into all business segments that we have. We’ve built a great board that has disciplines in each of these to help us continue to evaluate those decisions and make good decisions for our investors and our invested capital. As Kevin mentioned, we have our annual shareholder meeting. There’s not anything exciting on the shareholder plans, but if you haven’t voted your shares, please vote them. We look forward to an update sometime in the April timeframe to give you a little bit more detail on the markets. If you weren’t able to ask a question or if you’re listening to this on a replay, don’t hesitate to give me a holler and we’d be happy to give you any color or any information that would help you guide decisions in ownership of the stock. Thank you Mark. This concludes today’s conference. You may now disconnect your lines at this time. Thank you for your participation.
EarningCall_1467
Welcome to the Old National Bancorp’s Fourth Quarter 2022 Earnings Conference Call. This call is being recorded and has been made accessible to the public in accordance with the SEC’s Regulation FD. Corresponding presentation slides can be found on the Investor Relations page at oldnational.com and will be archived there for 12 months. Management would like to remind everyone that certain statements on today’s call may be forward-looking in nature and are subject to certain risks, uncertainties, and other factors that could cause actual results or outcomes to differ from those discussed. The company refers you to its forward-looking statement legend in the earnings release and presentation slides. The company’s risk factors are fully disclosed and discussed within its SEC filings. In addition, certain slides contain non-GAAP measures, which management believes provide more appropriate comparisons. These non-GAAP measures are intended to assist investors’ understanding of performance trends. Reconciliations for these numbers are contained within the appendix of the presentation. I’d now like to turn the call over to Old National’s CEO, Jim Ryan for opening remarks. Mr. Ryan, please go ahead. Good morning. Earlier this morning, we reported strong fourth quarter earnings, which put an exclamation point on an incredible year for Old National, one that saw the closing of our transformational merger with First Midwest, successful completion of all related systems conversions, tremendous client growth, and strong talent retention and attraction. The strength of our combined franchise is evident in the results outlined on Slide 4. Adjusted EPS was $0.56 per common share, representing a 10% increase quarter-over-quarter with a strong adjusted ROA and ROATCE of 1.46% and 26.5% respectively. Our efficiency ratio was a record low of 47.5%. I'm pleased to share that we achieved the quarterly expense run rate necessary to fulfill our 109 million of modeled merger expense savings. Moving to Slide 5, we reported GAAP earnings for the entire year of $1.50 per common share. Our adjusted EPS was $1.96 per common share, representing a 13% increase over 2021. These robust quarterly and annual results with peer leading returns were driven by a focused execution on our successful merger, maintaining our strong low-cost deposit franchise, growing loans with consistent strong credit standards, and disciplined expense management. We were also pleased that the policy balances remained relatively flat for the year, excluding the recent sale of HSA deposits, while maintaining our deposit pricing discipline with a low 12% deposit beta cycle to date. Another highlight of the year is our continual investment in top revenue generating talent across our footprint. Our story resonates well with these individuals and our talent pipeline remains robust. You may have seen our recent press release last week with the official launch of our 1834 high net worth wealth management brand. This is a fantastic opportunity to leverage our combined franchises strength and recent talent investments. We are already adding new clients to 1834. As we look forward, we feel good about 2023 and expect loan portfolios to continue to grow, albeit not at 2022 pace. In other areas, it should be more the same, below peer deposit costs that drive a funding advantage, more organic growth in our wealth management client base, a continued focus on a disciplined expense management. While we don't see anything meaningful on the horizon that gives us cause for concern on credit, we know that our granular portfolio, attention to client selection, and consistent underwriting guidelines as well as their active approach to credit management will serve us well if the economy turns worse. In other words, we intend to stay on the offense, but we are well positioned to withstand any new challenges that lie ahead. Thank you. I will now turn the call over to Brendon for further details. Thanks Jim. Turning to the quarter’s results on Slide 6, we reported GAAP net income applicable to common shares of $197 million or $0.67 per share. Reported earnings include a $91 million pre-tax gain from the sale of our HSA business, which was partially offset by $27 million in pre-tax property optimization charges and $20 million in pre-tax merger related charges. Excluding these items as well as debt securities losses, our adjusted earnings per share was $0.56. Slide 7 shows the trend in total loan growth excluding PPP loans. Total loans grew $606 million, led by commercial growth of $438 million and consumer growth of $168 million. Both commercial and consumer grew an annualized 8%. The investment portfolio decreased by 1% quarter-over-quarter due to reinvestment of portfolio of cash flows in support of loan growth. We expect $1.1 billion in total investment cash flows over the next 12 months. Slide 8 provides further details of our commercial loans and pipeline. The strong fourth quarter growth was well distributed with 8% annualized growth in C&I and 7% in CRE. Q4 production puts some pressure on the pipeline, but loan demand remains healthy and we expect continued organic loan growth in the mid-single-digit range. Turning briefly to pricing, new money yields on C&I increased 92 basis points from Q3 to 6.21% with new CRE production yields up 131 basis points to 5.86%. We've maintained our pricing discipline throughout the rate cycle and are pleased that our spreads have remained stable. Slide 9 shows details of our Q4 commercial production. The $2.7 billion of production was well balanced across all product lines and major markets. In addition, all of our product segments posted quarter-over-quarter balance sheet growth. We are pleased with the contribution from our newest LPO markets, which contributed almost $200 million in production this quarter. Moving to Slide 10, average deposits excluding the HSA sale were down to 1% quarter-over-quarter with the mix of our non-interest bearing deposits stable at 35%. End of period deposits were impacted $382 million related to the HSA sale and an additional $400 million in seasonal public fund outflows. End of period deposits also reflect the beginning of the mix shift from interest bearing transaction accounts into time deposits. Our loan to deposit ratio combined with wholesale funding capacity and of asset liquidity in the form of our investment and indirect books provides us flexibility in this competitive deposit market. That said, we are actively defending deposit balances through competitive rates and pricing exceptions. We are also playing offense through various deposit specialists throughout our footprint. We are pleased with our execution of this strategy today as we have been able to generate new deposits sufficient to maintain stable overall balances. Market conditions have put upward pressure on deposit rates with average total deposit costs up 22 basis points quarter-over-quarter to a still very low 34 basis points. Interest bearing deposit cost increased to 52 basis points, resulting in an industry-leading cycle to date beta of 12%. Our granular low cost deposit base should continue to give us a funding advantage throughout the remainder of this rate cycle. Next on Slide 11, you will see details of our net interest income and margin. Both metrics exceeded expectations, largely due to the outperformance of our deposit beta assumptions. Net interest margin expanded 14 basis points quarter-over-quarter to 3.85%, with core margin excluding accretion up 30 basis points to 3.75%. Slide 12 provides additional details on our asset liability position and projected margin range. Core margin for Q1 is expected to be in line with Q4 taking into account the six basis points of margin decline related to day count. Our outlook assumes deposit betas increasing from 12% today to a cycle to date beta in the first quarter of 20%. The assumptions in our outlook also included Fed funds target rate of 5% and a 4% yield on 10 year treasuries at the end of the first quarter. Specific margin guidance is challenging beyond Q1, but assuming the Fed cost is in Q2 and deposit repricing persists, we would expect pressure on margin in the back half of 2023. Also, while we remain well positioned for rising rates, we have been proactively adding downgrade protection, including an additional $400 billion of new hedges this quarter with an average floor strike of 4%. Slide 13 shows present adjusted noninterest income, which was $74 million for the quarter. This was generally in line with our expectations as market conditions continue to put pressure on mortgage and wealth revenues. The linked quarter decrease was also impacted by lower capital markets fees, which reflect lower demand for interest rate swap products given the rate environment. Fees were also impacted by one month of service charge enhancements implemented in December that were discussed last quarter. Again, we estimate approximately $5 million annual impact from service charge enhancements. Next, Slide 14 shows the trend in adjusted noninterest expenses. Adjusting for merger charges, property optimization charges, and tax credit amortization, noninterest expense of $230 million and our adjusted efficiency ratio was at historically low 47.5%. Expenses decreased $7 million quarter-over-quarter due to lower salaries and data processing expenses. Expenses were higher than anticipated due to $5 million quarter-over-quarter increase in incentive accruals given our strong earnings performance for the year. Excluding incentive adjustments, we are pleased to report that we have achieved a quarterly expense run rate consistent with our modeled cost synergies. We thought it would be helpful to provide additional detail on our 2023 expense outlook. We believe $225 million of the correct quarterly run rate to build off for your 2023 models. From this $900 million annualized base, we anticipate annual impact of $14 million in tax credit amortization, $11 million for merit, an incremental increase in FDIC expenses of $9 million, and approximately $10 million in strategic investments in both talent and technology enhancements. These investments will be partially funded with approximately $5 million in expense saves from the real estate optimization actions taken in Q4. Slide 15 shows our credit trends. Credit conditions are stable, and our commercial and consumer portfolios continue to perform exceptionally well. Net charge-offs were modest five basis points. Our special assets team is continuing to work through our PCD loans and expect charge-offs from this portfolio to increase but with variability from quarter-to-quarter. The provision expense impact from this effort should be minimal as we carry $59 million or approximately 5% reserve against the PCD book. On Slide 16, you will see the details of our fourth quarter allowance, including reserves for unfunded commitments, which stands at $336 million, up $8 million over Q3. Note that during the quarter, we reclassified both current and prior quarter allowance for unfunded commitments from noninterest expense to provision. Allowance for credit loss totals and metrics now include the allowance for unfunded commitments providing a more complete view of our allowance levels. This accounting treatment is also more consistent with peers and should aim at comparability. Reserve build was driven primarily by strong loan growth with relatively small increases due to portfolio mix, partly offset by improvement in our economic forecast. The financial health of our clients remain strong, and while credit metrics are stable, we believe it is prudent to maintain elevated reserves given the uncertainty in our base case economic outlook. Our current reserves reflect a relatively severe economic scenario, including negative GDP of 3.6% and unemployment of 7.2%, which is at the top end of our supportable range. Unless the economic outlook deteriorates materially, 2023 provision expense should be limited to portfolio performance and loan growth. In addition to the $336 million in reserves, we also carry $102 million in acquired loan discount marks. Slide 17 provides details on our capital position at quarter end. Capital ratios improved across the board. Our CET1 ratio grew to a very healthy 10% and our TCE ratio increased 36 basis points to 6.18%. Total OCI was stable quarter-over-quarter but is still impacting our TCE ratio by 155 basis points. We continue to monitor our balance sheet for economic stress and feel very comfortable with our capital levels. As I wrap up my comments, here are some key takeaways. We ended a transformational year for ONB with fantastic full year results and an even better fourth quarter. Adjusted EPS grew 10% and tangible book value per share grew 8% in the quarter. Key profitability ratios also improved from very strong Q3 results with an adjusted return on tangible common equity of 26.5% and return on average assets of 1.46%. We posted another solid quarter of quality organic loan growth and defended our deposit base well. Net interest income improved $15 million with 30 basis points of core margin expansion and an industry-leading cycle-to-date deposit beta of 12%. We are also pleased to have achieved a quarterly expense run rate consistent with our modeled merger cost synergies, resulting in a record low efficiency ratio of 47.5%. Slide 18 includes thoughts on our outlook for 2023. We believe commercial sentiment and our year-end pipeline supports mid-single-digit loan growth in 2023. Net interest income and margin should be consistent with the guidance we outlined earlier, with pressure from deposit repricing in the back half of the year. We expect our fee businesses to continue to perform well despite headwinds with mortgage following industry patterns. While our wealth business will be subject to market volatility, we are beginning to see revenue momentum from the strategic hires we've made over the last 18 months. Capital markets revenue was under pressure and should perform consistent with Q4 levels. Service charge changes implemented in December that are largely consistent with industry best practice, will impact full year 2023 by approximately $5 million. Our expense outlook is consistent with guidance we outlined earlier. Turning to taxes. We expect approximately $14 million in tax rate amortization for 2023 with a corresponding full year effective tax rate of 24% on a core FTE basis and 22% on a GAAP basis. With those comments, I'd like to open the call for your questions. We do have the full team available, including Mark Sander, Jim Sandgren and John Moran. Thank you. [Operator Instructions]. Our first question today comes from the line of Ben Gerlinger with Hovde Group. Ben, please go ahead. I appreciate the guidance that you guys gave on expenses and the waterfall is really helpful. When you think about 2023, I think, obviously, everyone is a little bit more skeptical in economic outlook. When you think about hires, I know that, that's kind of a priority longer term and investment in the company, taking decades rather than quarters, but -- is there any way you would possibly slow because you don't necessarily want to hire lenders going into a recession or any type of lending that you're really looking to lean into? Ben, I just think there's great opportunities for us to tell our story. When we get those opportunities and people are interested, I think we're always going to have a place for top talent. And Mark Sander said this really well, top talent will pay for itself. So while we'll be thoughtful and deliberate about all of our new hires, I think when given the opportunity to attract -- I mean, this is really the top quartile, top decile of each of the marketplaces. We're going to go ahead and hire those folks. But again, we'll be thoughtful if the economic outlook looks materially different than what we look at it today. We're going to be thoughtful about adding expenses and we'll be diligent about looking at ways to reduce costs as well. So -- but at this point in time, I just don't see anything different than the plan, which is to go ahead and attract the best possible talent we can to the organization. Got you. That's fair. And then obviously, hires just broadly speaking, in front of lenders. So when you think about the fee income line items, there's a lot of moving parts and a lot of different businesses. I know the recently announced wealth management is a big positive. But obviously, you guys can't project the full year fee income with mortgage as a volatile factor in that. But when you think about it, are we out of floor in mortgage and from here, do you think fee income rebounds holistically? Let me give you a 50,000-foot view, and then I'll have our CFO jump in. I'd like to think that mortgage doesn't get much worse than where we're at today, right. And a lot of the balance sheet -- a lot of the production we're doing today hits our balance sheet, not the fee income line. In terms of wealth, the good news is we're basically taking our business and dividing it into a couple of different businesses and 1834 is one of those businesses, right. There's not a big increase needed to staff that. And I would say that the talent we're looking for is both on the commercial side, business banking, but also the wealth management side. That's a big part of where we're heading. The good news is we have all the talent we need to get 1834 off the ground and running at a high level. So there's not a big required investment there. We do have high expectations that, that will grow kind of above our historic norms in that business despite what market conditions there -- market conditions are going to be what they're going to be. But nonetheless, we have pretty high expectations around our ability to grow that organically. And just before I turn it over to Brendon, Ben, I'd just add to what Jim said, a number of those hires that we put on in 2022 were in wealth management. So as we hire a dozen to 15 a quarter, probably half of those were -- so we're more than sufficiently staffed to grow in wealth. Brendon? The only thing left to add on that, Ben, to double-click into mortgage, I think we have to remember, year-over-year, 2022, at least in the early part of the year did include some elevated sale margin. So I would say, we're at a lower in terms of production, gain on sale margins today, but we were aided in the first half of last year by elevated gain on sale margins. So that will impact year-over-year numbers. I'd also like to think in the capital markets business, right. I mean it was a difficult time with rates rising very quickly. But those businesses find a way to adjust and offer new products or different products, particularly if there's a different set of view of rates emerging. So I think there'll be opportunities to grow that business. Obviously, the fourth quarter is a tough quarter for that business overall. Got you. And if I can sneak one more in, any appetite for potential repurchase or capital deployment, I know that you guys were historically looking to kind of support the growth, but if growth is slowing down into a recession, just overall thoughts on that. Yes. I think it's a little too early to want to jump in that. I think we need to have more clear picture of economic outlook, any issues related to credit out there. I think we need to have a much clearer picture before we want to jump on top of that. Thank you, that just seemed gratuitous but I certainly understand -- let's give you, Brendon, everyone's probably the most exciting topic I can think of. The -- so the margin -- you talked about margin pressure in the second half. Do you have a sort of thought for order of magnitude and maybe a sense for a lower bound where the margins could settle in the event that things do start to degrade? It's really hard, Scott, to pinpoint something. So much of this depends on what the Fed does. If the Fed kind of keeps their foot on the gas, we could see maybe even marginal -- margin expansion. If they pause for a while and deposits continue to reprice, loan demand remains relatively strong, I think that would be the kind of the worst-case scenario in terms of margin pressure. Just hard to know where those deposit betas fall out. The one thing we continue to talk to ourselves about is whatever that is, I think we have a competitive advantage. Our deposit beta was half the industry last cycle and I expect we can have a significant advantage over the industry in this cycle. Perfect. And I guess just for reference, when we talk about potential degradation in the second half, I know you're hesitant to offer thoughts beyond the first quarter, but is that 368 the best starting point for the margin or is something in like the low to mid-370s more appropriate, in other words, it goes down in the 1Q due largely to day count, does it go down and stay down or would it bounce back all else equal? All else equal, right, it would bounce back. And so Q2 would not have the same level of day impact. And then what happens in the back half of the year, I think, is really going to come down to where do deposit costs fall out? And we're heading -- if the market thinks the Fed is headed in the absent direction, right, I mean that can alleviate some pressure on deposit rates as well. Hi, maybe just a question, Slide 12, you've got the 10-year at 4% by the end of this quarter versus about 350 today. And I'm just kind of wondering how that could impact the outlook if the 10-year does not change? And then maybe as a follow-up since I'm on NII, do you think even with some margin compression in the back half of this year, the loan growth and the balance sheet growth can support growth in net interest income as we progress throughout 2023? Terry, I don't think it's not a huge impact from the 10-year moving around. It will impact a little bit of our investment book and fixed rate pricing book, but not a huge material impact. I would say the same thing with NII, certainly loan growth, earning asset remix will help support NII, but the total NII dollars again going back to the guidance. It's really going to come down to where deposit costs fall out and what does the Fed do in the back half of the year. Okay. And then maybe just stick with kind of the hedging strategy, added more swaps in the fourth quarter. Could you maybe talk about kind of the receive rate, duration of the additional hedges, and bigger picture, what's the strategy from here on protecting the margin from lower rates? Yes, duration on the hedges have been probably around three years. The average strike on that floor today is of the entire $2.2 billion is right around 2.6%. The most recent ones obviously have a strike significantly higher than that. So I think that will provide some meaningful protection. And as you think about it, as deposit costs continue to reprice up if and when the Fed starts to move, we've got a lot of support by being able to reduce deposit costs in the back half. So as we think about positioning the balance sheet towards a more neutral position, I think we're a long way towards that goal already. Maybe one last small question, if I could, is the tax rate creeping higher, that 24% core FTE, it just seems like I haven't gone back to past presentations, it just seems like it's kind of gotten higher over the last few quarters, am I correct and if so, what's behind that and if I'm not, then we can move on? No, you're correct. Absolutely. We added, obviously, with the SMB partnership we had a lot of earnings, but our tax credit business has not increased by novel. So we're working on strategies to continue to invest in that business, and we'll look to move that forward. But nothing in the near term that's going to change that. So we feel good about the guidance we gave you. Hey, good morning Jim. Brendon or Jim, the efficiency ratio you talked about 47.5% just being a great level. How should we be thinking about the trajectory of this metric, I know it's one metric, but balancing both sides of the equation, how do we think about directionally that the efficiency ratio were it kind of settles? Some obviously, we give you the expense outlook for 2023, where the efficiency ratio falls out will largely be a function of where revenue sit. But I can tell you that sort of this -- I don't know that we can repeat 47.5% but I do think for the full year, we're going to have a really strong efficiency ratio, and we continue to work on opportunities to continue to control expenses. Yes. I would just suggest that, Chris, we've had a long history of being very disciplined around the expense base here and it's obviously been nice to have some tailwind from the revenue side to help us out. But having said that, there's no magic bullets, there are no easy wins out there, but it's going to be a continued long-term focus on driving expenses lower. A lot of these come through just long-term enhancements through technology and business process automation which should help continue to reduce costs. So there's not any quick wins out there that are going to reduce it significantly, but it's just a continued focus by our leadership and management teams to make sure that we're driving our expense dollars and most efficiently we can. If I could just, I guess, push on that a little bit, Jim, I think in the deck, you say there's $5 million of savings coming from this branch optimization. The one timers, we'll call it 27, how do I wrestle with that kind of earn-back math, was there something I'm missing in that strategy like I would expect it a little bit more to fall, I guess, to the bottom line? Yes, I mean most of this was from real estate redisposition right. So the reality is, I think it's something less than a five-year earn back. That's a little longer than we would anticipate normally. But nonetheless, we think it was the right -- these were properties which are problematic, around 20 pieces of property in total. About half of those were in the branch world but very small branches. So again, something like over less than a five-year earn back, a little longer we'd like it to be, but appropriate for us, particularly given the HSA gain we had to reinvest. Got it. Great. And then maybe I could on credit. I think I'm getting some questions about what's the pace of reserve build. You guys have, I think, been viewed as very, very good on credit. SMBI's history is a little bit more chunky but overall, you kind of put them together pretty good credit. How do we think about, I guess, two questions, the pace of build based on your economic forecast and also how you view the kind of the normalized charge-offs of this pro forma company? I think we're in a good spot and that we really never released a lot of the excess reserves we carried in through COVID. We're continuing to put a pretty severe economic scenario through our model. So it's difficult for us to sit here today to think about a more adverse scenario coming through in reality. So we think provision is limited to portfolio changes and growth. And in terms of charge-offs, I think we've had a good run. I don't know what normalized charge-offs looks like. And going into next year or what the economy might provide to us, but I do think we have a significant amount of coverage on the PCD book that came over from FNB to 2% to 5% reserve against that book. So I think that will also go a long way in offsetting incremental provision expense associated with the merger. That's helpful. But the reserve at 98 bps, what's the -- I can do it, but what's the -- how do you view like the fully loaded reserve with the 5% mark on FMBI? Like what's the real metric you guys are tracking internally as like -- in terms of coverage? If you think about the -- I'm not sure. So if we think about the entire the $102 million of additional discount and credit overall, it's a 1.4% number. Good morning everyone. My question -- first question here is related to funding loan growth and loan growth, you've got a pretty decent expectation for 2023 with the potential for some deposit outflows, how do you look to fund that growth, it looks like securities you'll get a little bit there, but that may not close -- fill that whole gap? So we have opportunities in the mortgage book and the indirect book to an asset liquidity in those forms in addition to the investment portfolio. We also have a lot of wholesale funding capacity. And that said, we are still out there fighting hard for deposits, and we're going to work hard to maintain those levels. And as we go through, we -- granted, it's going to be a tough environment, but we're certainly not giving up and we're out there playing often. So -- the combination of those three items is how we're going to fund it, we're confident we have enough liquidity to make sure we support the commercial team and the growth of that book. Yes, I think we're defending our deposit base quite well. The ones and getting more aggressive where we have to. And you saw some of that repricing happened this quarter, consistent with the rest of the industry. And I feel confident in our ability to raise deposits. Deposit gathering is a large component of the goals in every one of our lines of business, and we're adding net new clients in every business. And so I feel confident in our ability to raise deposits as we need them, David. Okay, alright, great. And then you gave some commentary around the deposit service charges and the changes in some of the -- your products there. Is the fourth quarter number a little over 18 million [ph] -- is that the right run rate, is it fully baked in, or is there still a little bit more out of that to get to the right run rate into the first quarter? Yes, the service charge line has more than just the NSF fee items in there. It's only one month of the NSF related changes that have been baked in there. But I think if you look back at sort of a couple of quarters average, it's probably a better view of -- if you look at Q3 would be a better view of sort of more stable business and typical service charges. Okay, great. And then just to sneak one last one in here. On the operating expense guide, $939 million, I appreciate the color there. But I know you say it depends on the revenue side of the equation, but what are you assuming or can you talk about what you're assuming on the incentive compensation to get to that $939 million level? And how that impacts the revenue side? So $939 million, that would include incentives really at target as opposed to above target. Obviously, we were -- we benefited from a really great year this year. And so incentives were significantly higher this year relative to what we're projecting... It's consistent with the revenue expectations we also laid out, right. So if revenue goes up significantly, then clearly, we'd have some more incentive opportunity but given the revenue outlook we provided you and the expense base, I think those are consistent with each other. Question for you guys on loan growth. Brendon, you made a comment, I think I got it right, but some of the fourth quarter production put some pressure on the pipelines, but you still expect decent growth. What are you guys seeing in the pipeline, is it slowing? And what is your view on the cadence of growth you expect continued strong first and second quarter growth and it slows later in the year, just give us your thoughts on that? Well, I'll start and Jim Sanger can add a little bit Jon. I think we feel good about -- certainly, the pipeline coming down is a reflection of three really strong quarters of loan growth. And there normally is a little bit of reduction in the pipeline in Q4, so that's normal seasonal reduction. So when we think the pipeline is at a level that can provide the growth that Brendon laid out mid-single digits for full year of 2023. And the short term still looks good. I mean, as much as there's mixed signals out there in the economy, our C&I clients are still strong. They're a little more cautious than they were before, but there's still -- the business is solid and strong, and the liquidity and the balance sheets are good, and they're still investing. So CRE has slowed a bit. The interest rate environment has certainly brought down the pipeline there, and so we expect a less robust 2023 there. Jim, anything you'd add? I think that's really well said. I think our C&I customers actually feel pretty good about things. They are cautiously optimistic and continuing to invest. So, we'll see how that plays out the rest of the year. And to Mark's comments about CRE, obviously, interest rates are causing some pressure on the pipelines there. But we'll stay close to our borrowers and have opportunities to do the right deals with the right clients. Okay. You also mentioned deposit pricing exceptions and deposit specials were a couple of comments you made earlier. Can you talk about how prevalent that is and kind of what you're doing there? So we have special pricing and about 15%, 16% of our non-time deposit customers right now. So client by client, we're negotiating. We have given our teams tools to price as they need to, to stay market competitive and retain deposits. And as Brendon mentioned, we have a number of promotional specials in every line of business to raise closets from money markets to CDs to new checking account promotion. Okay. Brendon, you talked about $1.1 billion in cash flows on the securities portfolio over the next 12 months. What kind of a lift do you think you're going to get on those repurchases -- on the new purchases and give us an idea of what you're interested in buying and kind of the duration on that? A lot of the cash flow is actually built reinvested right into the loan book. So the lift is material. I think about the runoff the yield moving into new loan yields that are north of 6% today. So a meaningful uplift on those cash flows as we think about NII going forward. Okay. And then Jim, you'll love this one, but do you feel you're done with First Midwest, both sides of the merger, things are tracking well, and any appetite whatsoever to be back in the M&A market? Thanks. From a systems perspective, there's not a -- the project officially concluded. I think the reality though is we're continuing to look at ways to get better at what we do both in the back office and the front office. And then we're spending an awful lot of time on culture. Leadership team spent the last year really building a strong culture together. And now we're continuing to find ways to drive it deeper and deeper in our organization. So that work is going to take years, Jon, to continue to complete. But I feel really good about where we stand. In fact, we joke with ourselves I'm not sure we could have painted a better picture of how we come together as two organizations, two large organizations coming together. And so we feel really good about that. Obviously, the results, we feel great about the results given all that went on this year and so that couldn't actually feel any better. With respect to the next opportunities that come along, we'll continue to have active conversations and dialogues. But I can tell you, it's not top of mind for us to think about wanting to do something right now. But nonetheless, these are long-term relationship building activities we're going to continue to engage in and those will be important to our future. At the same time, we have an obligation to our shareholders to make sure whatever we do is really disciplined and shareholder friendly. So we're going to stay focused on organic growth and building out our teams with new talent. And then if the right partner comes along and it's the right fit and timing for us, we'll take a look at it. But there's a lot of ifs in there before we think about doing our next partnership. Hey guys, thanks for taking the follow-up. I just wanted to go back to the expenses, just so I am kind of crystal clear on it. So the $900 million launching point, that's a core number. But the $939 million expectation includes -- it looks like about $9 million of items that are not included in the starting point from the $14 million of tax credit amortization and the $5 million of property optimization. So would a more kind of apples-to-apples expectation to be $930 million for 2023, in other words, if you were to hit this guide, would you call the adjusted 2023 expenses, $930 million? We would call it $925 million. We would exclude the entire tax credit amortization. So $925 million of the asset because I know analysts treat that differently. Many of them exclude... Yes. Okay. So $925 million is kind of the underlying projection in there? Okay. And then the -- I appreciate that clarification, Brendon. And then when you talk about the 24% core FTE tax expectation for full year 2023 does that include or exclude the tax credit benefits? Oh, great, thanks. Brendon, the $1.1 billion that's coming off the bond book, I think you alluded that you probably will shrink the bond portfolio and put it into the loan book. I guess a question on how much of a remix we should think about for this year, ultimately, I'm trying to get at two things: the level of borrowings that you're going to have to do and your ultimate comfort with the loan-to-deposit ratio. Yes, we're comfortable with letting the loan deposit ratio increase from here. I think we have plenty of room. We have plenty of wholesale funding capacity. I think how much of that is -- how much of the borrowings are used for loan growth will be a function of how effective we are in maintaining stable deposits. [Operator Instructions]. There are no further questions at this time. I'd like to turn the call back to Jim Ryan for closing remarks. Well, thanks for all your attendance. I appreciate all the questions. We will be around all day long to answer any follow-up questions. Thanks, and look forward to talking with you soon. This concludes Old National's call. Once again, a replay along with the presentation slides will be available for 12 months on the Investor Relations page of Old National's website, oldnational.com. A replay of the call will also be available by dialing 866-813-9403 and the access code 104806. This replay will be available through February 7th. If anyone has any additional questions, please contact Lynell Walton at 812-464-1366. Thank you for your participation in today's conference call.
EarningCall_1468
And now at this time, I would like to turn the call over to Mickey Foster, Vice President of FedEx Investor Relations. Please go ahead. Good afternoon, and welcome to FedEx Corporation's second quarter earnings conference call. The second quarter earnings release, Form 10-Q and stat book on our website at fedex.com. This call and the accompanying slides are being stored on our website, where the replay and slides will be available for about one year. Joining us on the call today are members of the media. During our question-and-answer session, callers will be limited to one question in order to allow us to accommodate all those who would like to participate. I want to remind all listeners that FedEx Corporation desires to take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act. Certain statements in this conference call such as projections regarding future performance maybe -- certain statements in this conference call, such as projections regarding future performance may be considered forward-looking statements within the meaning of the act. Such forward-looking statements are subject to risks, uncertainties and other factors, which could cause actual results to differ materially from those expressed or implied by such forward-looking statements. For additional information on these factors, please refer to our press releases and filings with the SEC. Please refer to the Investor Relations portion of our website at fedex.com for a reconciliation of the non-GAAP financial measures discussed on this call to the mostly directly comparable GAAP measures. Joining us on the call today are Raj Subramanian, President and CEO; and Mike Lenz, Executive Vice President and CFO; and Brie Carere, Executive Vice President and Chief Customer Officer. Before we begin, I'd like to take a moment to remember our colleague, Jeff Smith, who passed away on November 17, after courageous battle of brain cancer. Jeff's contributions to the Investor Relations and FedEx team were immeasurable, and our hearts remain heavy at his loss. He will be greatly missed. Separately, I'd like to congratulate Elizabeth Allen on her upcoming retirement at the end of the month after 32 years at FedEx. Elizabeth has been instrumental to the Investor Relations team, and she will be missed by our FedEx colleagues and the investment community alike. Thank you, Mickey, and good afternoon, everyone. Let me begin by thanking our more than 550,000 employees who are working diligently to deliver another strong peak season for our customers. I'm extremely proud of the team's ability to sustain excellent services season while we continue to transform our global network vis-à-vis to the FedEx team. I'm encouraged by our second quarter results and the momentum underway against our Deliver Today, Innovate for Tomorrow strategy. We exceeded our Q2 earnings and cost action goals shared in September, even as the environment remained challenged. At the same time, there is more work to be done. The declining demand trends we saw at the end of Q1 softened further in the second quarter, and we are moving faster and with more determination than ever to accelerate our cost actions. Today, we will provide more detail on those cost actions and our plan to structurally transform our network to be nimbler, leaner and more efficient, supported by our DRIVE program. Turning to Slide 6 for a snapshot of the quarter. Volumes declined across all segments, primarily at Express down low double digits. As such, revenue was down 3%, driven by a decline at FedEx Express, which was partially offset by growth at FedEx Freight and FedEx Ground. Adjusted operating margin and EPS declined with volume weakness, partially offset by higher yield and cost management actions. All of this said, we knew coming into this quarter that we would continue to be challenged by volume softness and high inflation. I'm exceptionally proud of the team's execution to-date, which enabled us to exceed the second quarter earnings and cost targets. A great example of our meticulous focus on cost actions was a result at FedEx Ground, where, despite volume being down 9% in the quarter, we were able to grow both operating income and margin. And FedEx Freight due to operating margin improved 320 basis points due to the continued focus on revenue quality, aligning the cost structure to lower volume levels and delivering an outstanding customer experience. Now I'll provide an update on our aggressive and decisive plan to cut costs in fiscal '23 relative to our June plan. In Q2, we achieved over $900 million of savings, exceeding the cost target we shared with you last quarter. This brings our total year-to-date progress to $1.2 billion. As we look to the remainder of the fiscal year, we have identified additional savings, bringing our target for fiscal year '23 to be approximately $3.7 billion in cuts. Turning to Slide 8. As we execute these cost actions, we are also laser-focused on delivering upon the superior service that has defined FedEx throughout our nearly 50-year history. As I mentioned, our team is performing exceptionally well this peak season, with ground time in transit in the U.S. at just two days. FedEx Ground is delivering holiday shipments faster to more locations than our nearest competitor. Our ground service is now back to pre-pandemic levels, supported by continued enhancements to our route optimization and package handler scheduling technologies. Service levels also continued to improve at Express. In Europe, we have made strong progress with Italy, France, Germany, Spain and the U.K. showing sustained high levels of service performance. The service challenges at Paris Charles De Gaulle Airport have been largely alleviated, and we are capitalizing on efficiencies in the network to further improve service. We're taking swift action to address the remaining issues for our intra-Europe service, including the reopening of our Netherlands ground hub in October, which will continue to improve transit and depressurize the rest of the network and completing the Novara Italy road hub in February of 2023. Moving to Slide 9. I'll now provide an update on our ongoing structural transformation. We have spent 50 years building our networks and growing our portfolio. As a result, we now have the most extensive network of any provider in the industry. We are now focused on optimizing this network to realize our full value potential. This includes advancing our global transformation through DRIVE, our comprehensive program to support long-term profitability and deliver on our fiscal year '25 financial targets. DRIVE is how we are executing that strategy, achieving more than $4 billion in annualized structural cost reductions by fiscal year 2025. I'm confident I have the full commitment of our executive team, our Leading DRIVE with purpose and a sense of urgency and of Sriram Krishnasamy, our Chief Transformation Officer, who is facilitating the program. We have identified 14 specific focus areas, which we call domains to target for efficiency improvements. Each is led by an executive sponsor and is aligned around a strategic vision for the business. We are measuring success against each domain's FY '25 permanent cost savings target in addition to using clear operational metrics to track financial and service level progress. At Express, the team is transforming the network to be more agile, efficient and digitally led. An initial priority is to optimize the global air network where we expect to generate approximately $400 million in savings. This work includes deploying digital assets that allow us to efficiently balance our Purple tile airplanes and third-party lift as we build the network of the future. We are also addressing our express pickup and delivery operations globally to improve efficiency. In February, we will implement a new U.S. network design that will improve P&D efficiency and result in cost savings of approximately $300 million annually. In Europe, where we expect over 1/3 of Express' drive savings, we have spent the last several years bringing the networks together. With integration behind us, we have shifted to optimization. We're adjusting our network, deploying route productivity tools and investing in digital capabilities for planning and automation. Additionally, we are rightsizing our intra-Europe air network and improving processes to enhance the end-to-end customer journey. This will all serve to improve both service and profit of our European business. Now turning to FedEx Ground. We are focused on every portion of the package life cycle. For instance, in line haul operations, we are applying new tools, technology and processes to drive increased packages per trailer. Within Ground, we have a dock domain. This team's responsibility is to improve packages per labor hour. In Q2, that metric increased 3.5% year-over-year, and we expect continued improvement as we deploy additional capabilities. Across both the Express and Ground focus areas, we are leveraging our operational insights platform. This provides the foundational data, tools and insights critical not only for delivering DRIVE savings goals but also for sustaining those savings and transforming the way we operate. Finally, shared and allocated overhead expenses are a significant opportunity. This includes procurement and digitizing and centralizing support functions. One example of digitizing support functions is our ability to reduce customer service calls by redirecting customers to best-in-class digital applications, a win for FedEx and a win for our customers. Within procurement, we are reducing spend through our operate collaboratively model and creating a central function to optimize our enterprise spend. For example, we are setting up a cross-OpCo initiative to consolidate our contract transportation spend to realize value in the second half of fiscal year '23. We will continue to provide updates on our DRIVE progress, and we plan to host a DRIVE deep dive call in the first half of calendar 2023 and to provide additional details on our ongoing transformation. Now let me turn it over to our Chief Customer Officer, Brie Carere, to discuss recent market trends and our commercial strategy in more detail. Thank you, and good afternoon. As expected, the operating environment in the second quarter was challenging. The trends we saw toward the end of the first quarter persisted through November. As a result, we experienced lower demand for FedEx products and services, but we acted with urgency to adjust our network while continuing to deliver for our customers. Revenue at FedEx Express was down 3% year-over-year, primarily due to volume and yield softness in Europe and Asia. In Europe, we're making steady progress as volume trends improved quarter-over-quarter. I am confident in our momentum as we have a robust sales pipeline in Europe. We are leveraging our faster road network and our unique ability to bundle parcel and freight. As we anticipated, the softening demand created yield pressure, especially in Asia. Despite volume softness, I am pleased with the team's ability to manage volume, share and margin in our trans-Pacific lane. At FedEx Ground, revenue was up 2% due to higher yield driven by fuel surcharges, base rate increases and improved product mix. It was partially offset by lower volumes. We once again delivered strong service levels and best-in-market transit times. At FedEx Freight, we delivered solid performance despite the operating environment beginning to moderate. Pricing discipline across the LTL industry is strong, and we expect the market to remain rational. Revenue was up 8% as the team remains laser-focused on driving improved revenue quality and profitable share growth. While navigating the current environment, FedEx Freight continues to innovate. We're expanding dimensional capture and piloting dimensional weight-based pricing. We believe this simplified pricing is the future of the LTL industry, and we're leading in this transformation. I also wanted to provide an update on our enterprise pricing strategy and the initiatives to improve revenue quality. We remain disciplined. We are focused on growth in the right segment to optimize network profitability. We announced a 6.9% general rate increase in September, and I remain confident in a continued high capture rate. We are also continuing to leverage surcharges to align our pricing to cost. Our recent announcement for demand-based large package and U.S. export fuel surcharge are good proof points. I'm also very pleased with the team's progress to create new capabilities. A great example is the partnership between pricing and DataWorks to build a price anomaly detection engine. The team has had success detecting overbilling and correcting invoices before they are sent to our customers. This is a significant customer experience improvement. We are now adapting these capabilities to identify underbilling opportunities, which will increase revenue quality. As we look toward the back half, service improvement has translated into good momentum for our sales team. In addition, we have a robust pipeline aligned with our strategy, which includes small and medium and European segment targets. In Q4, we will be lapping the impact of the beginning of the war in the Ukraine as well as the air integration disruption we experienced in the region. As a result, our year-over-year volume comps will improve as we move through the back half of this fiscal year. However, in Asia, we do expect to face continued yield pressure due to lower demand for priority services. In the current economic environment, the market is increasingly shifting to deferred services. We have the deferred portfolio to capture the shift in demand, and our DRIVE program will ensure we have the right cost to serve to profitably manage through this market transition. In conclusion, we remain prudent in our expectations for volume and yield in the second half of the fiscal year. That being said, our service value proposition relative to our competition will remain strong. And in fact, our relative market position will improve in the back half of the year. Thanks, Brie. I'll start on Slide 16. In the second quarter, we delivered improved alignment between variable costs and lower revenue amid a more challenged volume environment that impacted our profitability. Second quarter revenue was approximately $700 million below the lower end of the range we expected coming into the quarter. Approximately $300 million of this variance was due to an accelerated decline in forwarding revenue at FedEx Logistics. The remaining variance versus our Q2 outlook was driven about half by Express and the balance by Ground and Freight combined. We have moved faster to offset this shortfall with cost reductions, reducing the lag between incremental volume softness and the savings offsets realized. This, combined with an additional $200 million in discrete cost actions, led to improved earnings relative to our Q2 outlook. Turning to the Transportation segments. Starting with Express, profitability continues to be pressured. Adjusted operating income declined 65% due to lower volumes as cost reductions lagged accelerating volume declines. Volume pressures were partially offset by yield management actions. Package yield grew 8% year-over-year, primarily driven by higher fuel surcharges and base rates, partially offset by exchange rate impacts. Yield improvement slowed from Q1 levels across nearly all products and regions. In Ground, operating income increased 24% and operating margins expanded 130 basis points to 7.1%, supported by yield growth of 13% as higher fuel surcharges, product mix and pricing initiatives drove improvement. Our cost reduction actions, combined with solid execution by the ground team to adjust near-term variable costs amidst greater volume declines also supported margin improvement. These factors were partially offset by increased costs, including higher purchase transportation and other operating expenses. And at Freight, the team continues to drive strong profitability with operating income increasing 32%. This was driven by yield improvement, including higher fuel surcharges, partially offset by decreased shipments as well as higher wage rates. Turning to Slide 17. I'd like to build on what you heard from Raj on our near-term cost savings, reviewing our progress by category. As mentioned, we've identified $3.7 billion in discrete cost reductions relative to our plans going into fiscal '23, which is $1 billion higher than our prior projection. Express is where we have the most work to do and where the majority of the reductions are focused. A large portion of those savings is coming from reduced flight frequencies. Year-to-date, we've reduced eight international routes and 32 U.S. domestic routes, while parking five additional aircraft. This translates into pulling down U.S. domestic flight hours by 6% and international flight hours down 7% in the second quarter year-over-year. Moving to 18. In addition to the expense actions, we are also lowering our FY '23 capital spend forecast by an incremental $400 million to $5.9 billion, which represents an approximate $900 million reduction from our initial plans for the year. With the lower demand environment, we're deliberately deferring and slowing the pace of projects as we maintain the emphasis on using our assets more efficiently and reducing our overall capital intensity. Our liquidity remains a source of strength, and we ended the quarter with $4.6 billion in cash. We continue to generate solid cash flows supporting our capital return strategy. We executed a $1.5 billion accelerated share repurchase transaction, which will be completed by the end of this calendar year. Our capital return strategy reflects our commitment to reducing capital intensity and creating value for shareholders while continuing to reinvest in FedEx for today and tomorrow. Provide additional context for the changes in demand during the first half and what we are planning for in our outlook, on Slide 19, we've shown first half monthly volume trends for our major product categories. Volume declines continued to accelerate across major product categories, both in the U.S. and internationally throughout the second quarter. As we look to the second half of the year, we expect volume declines to begin moderating in Express and Ground by the end of the third quarter with comparisons easing further in the fourth quarter as we lap the onset of softer volumes. This brings me to our outlook on Slide 20. While we continue to aggressively drive cost reduction actions, we expect business conditions to remain challenging in the second half of FY '23. Our current expectation for full year adjusted earnings per share is between $13 and $14. On a quarterly basis, we expect results to follow our historical seasonal pattern with lower earnings in the third quarter versus the second quarter and highest in the fourth quarter. Second quarter adjusted expenses were essentially flat year-over-year as inflation impacts, particularly fuel, offset our activity reductions on an absolute basis. As we move through the second half, we project year-over-year expenses to increasingly decline as our cost initiatives accelerate in conjunction with lapping certain inflationary increases. Closing, I'd like to reiterate that the entire team continues to aggressively identify and implement both immediate cost reductions as well as structural cost efficiencies to drive improved performance. Yes. Wanted to see if you could give a sense of what drives the $1 billion in cost take out. And then I don't know if you look at the broader frame. Raj, you talked about some of the split. But can you give like the detail or a bit of breakout from Express, Ground and shared services on the $4 billion number also? Hey, Tom, this is Mike. So first, for the additional $1 billion for FY '23 relative to our plans coming into the year, that's mostly at Express. It's a combination of further flight reductions, incremental sort cancels, particularly post peak, adjustments to our ground operations primarily in the pickup and delivery space. And then I guess another piece I'd highlight too was further reductions at our FedEx services, shared services organization, where they're doing a great job of really clamping down on cost relative to what we were contemplating earlier in the year. As it relates to the $4 billion in DRIVE, we've highlighted $1.4 billion is for Express, $1.1 billion is Ground and then $1.5 billion is in the shared and allocated expenses. And keep in mind that as we approach those, those are structural cost reductions that are irrespective of the demand environment assumption that you would make going forward so that we can achieve a path towards the FY '25 objectives that we outlined. Thanks for the question. Just one question related to the reduction in CapEx, Mike, you talked -- you're moving -- just to clarify, you're moving to the right, and you will still spend that money, you will just not spend it this current fiscal year. Is that correct -- is that correct? So, we certainly have deferred a number of facility projects and initiatives. So that is a component there as well as looking to pause other certain major projects at a phase of completion as we evaluate the chain circumstances. Another piece of it is a change in our aircraft payment schedule as well. So, we've pushed that out further, but the number of deliveries remains unchanged, just a timing in that sense. Okay. And then could I just ask a follow-up on -- with respect to salaries, wages and benefits. I sort of thought that there was some decline there that looked kind of okay. Could you just explain that? Because you also said during your prepared remarks that salaries were actually up. So kind of missed that. Well, so Helane, we will see mitigating in terms of the year-over-year increase in wage rates relative to what we were seeing earlier in the year. And in addition, as we flex down the networks, particularly post peak, we'll have a ramp down in terms of the resources deployed there as we typically do, but certainly going to move quickly as we come past the successful peak that we're in the middle of right now. So expect further progress in that line going forward as well. So, a question on the $13 to $14 range. Maybe some more perspective, obviously, you beat in the second quarter, you're upping the cost saves by $1 billion. I mean how do we think about that from a conservative perspective? Is it conservative? And -- or maybe some context in your view of the economy. I mean are we assuming a recession in those numbers because it would seem, especially with the monitoring decline in volume, that the cost saves are basically all the second half operating profit. So, I'm just wondering if you've kind of taken a very conservative approach. Sure. Thanks, Jordan. Well, I would highlight, certainly, the environment remains fluid. We outline our expectations on the trajectory of volume and yield and considered a range of outcomes within the corridor for both of those. And in conjunction with the cost take out you highlighted there, we're very confident with the $13 to $14 range. So while it's true, the volume declines, we expect those to moderate as we move through the rest of the year, particularly in Q4, we're going to have more yield pressure relative to the increases we saw in the first half of the year. So when you bring all three of those elements together, that's what gets you to the bottom line projection there that we've highlighted. But I guess I would also say that while the declines moderate on the volume, we're in essence, projecting the same demand profile that we're currently experiencing. So hopefully that puts it in full context for you. If we could just take that maybe a step further, it seems like that I think Jordan just hit it on the -- you have $1.2 billion of savings so far. So of your 3.7 target now, the 2.5, that means all of the second half savings. I just want to clarify the $7.30 or whatever to seems like it's all from cost savings, right? And so the new found $1 billion, does that mean you were targeting maybe $10 to $11 of earnings before that, given that you -- that gets you to the back half? And I guess, Mike, if you can kind of specify what of that is then structural versus adjusting for takeout given the pace of volumes you're seeing? Okay. Ken, how I would address that is as you saw in the second quarter, the revenue environment was below our expectations. So therefore, we are assuming that going forward into the second half of the year, which motivated further near-term takeouts of cost relative to what we had planned for FY '23. So we will project revenues to be down year-over-year in Q1, but we're also going to see a ramp-up in absolute expense reductions as we move through Q3 and even more so into Q4. So that's the absolute basis when you look at it for year-over-year. And so that -- are these -- again, just to clarify that, does that mean these are just reaction to the slowing revenues, and so it's cyclical versus -- I'm just trying to understand your -- I think investors want to understand what is structural moves that FedEx is making here versus just reacting to the decelerating revenue environment. Is there a way to clarify that? Well, Ken, maybe we talked about a permanent reductions of $1 billion from FY '23. And that recognizes we were operating in very unique circumstances over the last 1.5 years, 2 years. And so those takeouts would not return under any range of normalized demand scenarios that you might consider. And of course, most of that's in Express. I mentioned that we parked five additional aircraft during the second quarter. By the end of the fiscal year, we're projecting to park 11 additional aircraft. So hopefully, that gives you a little more context for how we're thinking about resizing the network and most of those will be wide-bodies. Mike, can you just talk about the margin expectations for the segments in the back half? Can Ground continue to improve? Can Freight continue to improve? Can Express get back to margin improvement? And then Brie, sounds like you were talking about pricing slowing. I wasn't sure if that was a parcel comment, an LTL comment. So if you could just give us a little bit more color. Okay. Scott, I will start. Express margins will remain pressured in the second half I would say more so in the third quarter versus the fourth quarter. Given some of the factors we outlined, including ramping up more of the discrete cost reductions into the fourth quarter, we're fully seeing traction in Europe, plus lapping the challenges from last year with the air network integration as well as lapping the volume inflection there. So, Express remains a -- where we have the most work to do. I would say at Ground we're past the rapid growth and labor challenges that the Ground team was executing on over the last two years, and now they are laser-focused on driving improved productivity and efficiency within a declining volume environment. And so we saw great progress in that regard here in the second quarter and expect to see continued going forward in the second half of the year. So hopefully, that gives a little dimensions to the pieces of it. Brie, do you want to take? Sure. Fair question, Scott. So from a yield perspective, let's talk front half versus back half. When we look at the domestic parcel market, we are still anticipating in the back half that we will have growth both Express and Ground in the parcel market, although less growth than we did in the first half. The same holds true for FedEx Freight domestically. Back half, we are still anticipating yield growth in the inflationary environment, although much less than the front half. And then as we go to the international markets, the largest change that we will experience in the back half is we are anticipating that we will see our Asia yields decrease in the second half. Now I want to be really clear that we've accounted for that within the range that Mike has given us, and we also anticipated this. And the Asia team does a really good job of managing volume, yield and margin. And our trans-Pacific lane is still a very profitable and healthy lane for us. So it is within the range, but that's how we're thinking about yield front half versus back half. And I second Ken's thoughts on Jeff and Elizabeth. Guys, can you just help us understand, I mean, if you're going to achieve $3.7 billion this year, isn't that very similar to the 2025 DRIVE target? I think that might be the confusion that a lot of folks aren't fully understanding here. And Mike, we heard you that $1 billion are permanent this year. But can you talk to maybe the other $2.7 billion that might come back, but then you're going to shed an incremental $3 billion between now and then? So Brandon, let me, first, thanks for the kind comments regarding Jeff and Elizabeth. We will certainly miss both of them. Let me get a little more context about the $3.7 billion reduction. Appreciate that's reference to our plans coming into '23. And the purpose of that was to illustrate the scope and magnitude of the cost initiatives that we have undertaken to address the changed circumstances from where we started the year. So we highlighted we have $1 billion of the permanent reductions. In a demand environment as we are today, much of the structure, the flight takedowns that we have made it Express, you wouldn't see those coming back. I think you may recall, we said there will always be -- anticipate that there will be cyclical ups and downs. But as we come out of the current circumstances when it comes back, it would come back in a different way, and we would be using less of our own Purple tail lift and more of partner-lift in order to flow traffic in the most efficient manner possible. So again, the $4 billion of DRIVE, think about that in the context of a greater emphasis on cost reduction rather than the degree of modest revenue growth we were assuming back in June when we outlined the goals for FY '25. So that's what the focus is there to that structural cost reduction across a range of demand scenarios that you could envision. I just want to follow up on the last comment. So just to clarify, the fiscal '25 targets is certainly the balance of revenue and cost based on sort of the macro deceleration. Is that algo clearly changed in terms of how you reach those targets through fiscal '25 just given some of the structural cost actions and challenging growth right now? Yes, You hit it. Absolutely, Allison, we are -- that's why we have ramped up the degree and intensity around the structural cost reductions. We made great progress to date in identifying those and are looking to use the insights as we've made progress on those to identify even more. And if the environment changes, then we will react as you saw in the second quarter here to adjust even further in the near term as well. So Raj, I was wondering if you could maybe kind of bring this stuff up a level, right? If we're talking about $13 to $14 in adjusted earnings in this fiscal year, is that a base from which you can start to build in fiscal '24 and '25, or are we still got a little bit of risk in terms of chasing the ball down the hill from an economy standpoint? And then as you think about the longer-term targets that you put out there, is there any contemplation of actual changes to the product portfolio or the composition of the many different companies that make up FedEx as part of this transformation effort? Or are we just kind of doing the same sort of mix of stuff a little bit better? So David, thanks for the question. And so, I'll just say that I'm just delighted to see how fast we're performing in terms of taking our structural cost down. So, the -- I'm just going to comment on The DRIVE program here because that's what gets us going to the FY '25 goals. Our strategy is simply is to drive profitable growth and reduce our structural costs while we innovate digitally that helps us get to those goals. And all this built on a strong foundation of service. DRIVE is how we execute that, and I'm extremely thrilled to see the progress we have made and the level of engagement of the entire executive team. We have, as I showed in the slide earlier, the 14 domains each with an executive sponsor, KPIs are identified, we have about 1,200 people involved. And this is not a one-and-done exercise. This, all the way from initial idea to an executable plan with KPIs, this is like a conveyor belt. And then there's a significant amount of will, scale and rigor as teams move towards execution. So this is very important as we think about FY '24 and '25. We are fundamentally focused on restructuring our cost base, driving profitable growth and improving our operating margin performance. So we can't control what the external environment is. We are focused on things we can control. And the base that we have in '23, we will use that to come out of this external environment situation much, much better than we went in. And the DRIVE program is a significant component of that and talk to you more about that drive deep dive update you in the first half of calendar '23. We are constantly looking at the portfolio to see what opportunities that exist. And when there's something to talk to you about that, we will definitely communicate. Thank you, David. I guess I wanted to take maybe a higher level of macro question here. You mentioned continued yield softness in Asia. I'm surprised, I guess, to hear that the China reopening wasn't mentioned at all the potential tailwinds. I'm kind of curious what your guys thoughts are in terms of what's continued to drive that age happening if kind of potentially come back online as an economy and then maybe noting that we haven't talked about broader economic outlook and you guys giving the monthly economic updates. Maybe if you had any thoughts on just general U.S. economic conditions here looking over the next 12 months. And let me hit a high level and then Brie adds additional details, we can jump in right afterwards. On the macro aspects of it, the two things we flagged were that the industrial economy is slowing around the world and with Europe being the hardest hit and that there is an e-commerce reset, and both those things happened exactly like we said we're going to happen. The good news was we reacted -- we moved much faster to adjust to these circumstances. And we are absolutely focused on what we can control. And again, I'm very, very proud of the progress we have made. And -- but again, we know there's more work to be done, and we will continue to improve our cost structure. Regarding China, we haven't seen any fundamental change in the volume profile one way or the other in the last few weeks. We are obviously monitoring this very, very carefully, and it's very too early for us to make any further comments on this at this time. Brie, anything to add here? No, I think that's exactly right. We have the team poised and ready to benefit from any potential. But right now, the demand signals have been pretty consistent over the last couple of weeks, and so that's how we're planning for the back half. Okay. Great. So I guess, Raj, this one's for you, and I love Mike's thought as well, but I would be curious to kind of get your take on structurally what's changing as you look out over the next several years with how the Company is allocating capital. I get that there's a greater emphasis on capital efficiency overall. And I think everyone appreciates the fact that you guys are monitoring the CapEx issue very carefully. But as you think about your decisions to invest for both organic and inorganic opportunities, there have been some challenging sort of investments over the past decade. How is the sort of the framework around how you're thinking about capital allocation changing, if at all, as you look forward, Raj? Okay. Thank you, Jack. Listen, we are -- the drive is the way we work and every project that we now go through has started to go through a significant hurdle to make sure those plants are approved and then, obviously, that has to make sense from a financial perspective and from an ROIC perspective. So good news so far is that projects that have come through here have -- we are very high returns, and it changes the fundamental way we think about how we go forward here. So Mike, I don't know if you want to add to that comment. Jack, look, the high rate of growth, particularly at ground over the past few years, that's in the rearview mirror. And so, we will not be spending as much on facility expansion going forward. The major replacement initiatives we have in front of us over the next couple of years, which ramped down in FY -- beyond FY '25 are our fleet modernization. We have no firm orders beyond FY '25 for new aircraft and the modernization of our Memphis hub, which is, as Richard likes to call it, the heartbeat of the Express network. That will be completed in a few years as well, and that will yield efficiencies over the long term. So those are major elements within the capital allocation that we have a clear line of sight of those coming down. And hence, as we outlined, we fully expect to be it the 6.5% in '25 and lower beyond that. And hence, we were committed to improving our payout ratio and up the dividend as a reflection of the trajectory and the path that we're headed down in that regard. Raj, I wanted to get in on what you think about the domestic economy. It seems like the step-down in volume activity in the second quarter seemed to be more driven by domestic across the segment. So kind of curious if we're seeing some of the softness that you had originally flagged in the late summer and into the fall in international sort of cascading here into the U.S.? Or are there maybe some specific customer actions or revenue quality actions that you're taking here in the U.S.? Well, let me just talk about the macro environment. I think the main macro issue in the United States is really the e-commerce reset. If you were to just follow along here prior to the pandemic e-commerce represented about 16% of retail. During the pandemic, it peaked at about 22%. And ever since, it's been kind of going down. We are probably about 18% or 19% right now. It's still higher than 16%, but not quite high as 22%. So that's the part of the reset that's going on in the U.S. domestic package business. Of course, we have also taken certain revenue quality actions on some of the segments of the traffic, specifically FedEx Ground economy. And so that's the only other part that would be unique to FedEx. But other than that, this is, I would say, the biggest macro here is e-commerce reset. So Mike, I just wanted to ask maybe a couple of quick ones. So I wanted to understand the drag in Express coming from the European Ground business, so basically the legacy TNT business? Because I understand there's cyclicality in the air network and you're bringing flight hours down, which is great. But I'm just trying to understand what the legacy TNT business, what the overall impact that has had or will have on kind of the express proper profile. I don't know if that means that you can give us an idea of what that business is making or losing or the contribution of that is to the overall Express profit, but I think that would be helpful. And then the follow-up I wanted to ask was on the Freight business. And I don't ask a lot of questions about the Freight business, but it's a big piece of the profit pools today? I don't know if Lance is on, but what I noticed is the yields in the freight business were down sequentially, which is something we typically haven't seen quarter-on-quarter. And of course, this is in the context of FedEx being part of kind of that pricing war 12 years ago in the LTL business. Is this an indication that FedEx is lowering price to get more volumes in Freight? Can you talk about the pricing discipline in the Freight business, both with respect to FedEx and also as the industries you see it as well? So look, the opportunity in Europe is a significant driver of the upside potential for Express. We've highlighted the challenges that we had earlier in the calendar year. We have worked past those. The team has momentum there. The leadership team is very focused on winning business, driving more efficiency activity both in the air and in the ground network and fully confident that we will see significant contributor to improvement in Express' profitability going forward with some initial traction on that coming in Q4 in terms of seeing a year-over-year improvement. So that is absolutely an opportunity for Express, and we certainly are confident of getting there. It's taken longer than we would have anticipated. And we've had some events develop along the way, but we're past those, and we're looking forward. Brie? Thanks Mike. Fair question from a FedEx Freight perspective. When we looked at Q2, the one thing that we did see that was slightly different from Q1 is weights actually were slightly down in Q2. From a revenue quality perspective, however, we have to remember, number one, that we are seeing all of the public carriers behave very rationally and the market is very disciplined. Number two, within that market, FedEx Freight has the premium value proposition. We have two types of service. So, we have a great opportunity that is very profitable for FedEx for allow customers to move from our priority to our economy service. And we've got two great opportunities within FedEx, right? We've got FedEx Freight Direct, which we're still seeing high demand for. And we've got a very profitable service into Canada that we're very focused on. So we are going to continue to be disciplined. We absolutely know the history, and we are focused right now on doing our part to be very disciplined within the industry. Raj, one for you and then one for Brie. Raj, you've given a good overview with regard to DRIVE. I'm just curious when in the first half, we may expect this update call and what type of information we'll receive there, these 14 domains you're targeting, maybe you could speak to the there, I'd be curious to hear? And then, Brie, the question for you is you spoke about improving service levels and a really good pipeline for small and intermediate-sized businesses. Could you delve into that a little bit more on how that's working for you and the sales team domestically and in Europe? Well, thank you, Scott. On the -- yes, on the DRIVE part of the equation, we have, again, as I said, we are very excited about the progress we're making here. The -- some of the -- there are 14 domains under Express. We have the air network domain this is about fundamentally restructuring our Express air network to be more agile and flexible to changes in demand and also recognizing that deferred parcel and freight will be a bigger component. So how do we change our networks firstly, to improve our loaded density and then how do we use partner network, especially to move deferred traffic. And then also looking at the domestic U.S. network to see what efficiencies we can get there using technology. The other one is Europe is part of the domain here and is clearly a big area for focus for us. We have $1.1 billion of this is FedEx Ground. There are very interesting opportunities there, whether it is through line haul or dock productivity, things like that. And then, of course, back-office shared services is $1.5 billion with this procurement and improving our efficiency across the board. So, I don't want to take the time here to go through all the detail, but I will -- we'll set up a time we haven't decided on an exact date yet, but at that meeting, we will give you more detail. We'll talk to you about specific KPIs that we will try going forward and give you a full flavor of what this program is all about. And Brie? Thanks, Raj. So I love this question. Let's talk about our momentum. Here in the United States, as we talked about, we've had a great peak. The ground team and I know the operators who are listening, I know we're not done yet. I know we have a very, very busy week still to execute. But as I sit here right now, we've had just stellar service in the field, and I couldn't be more proud of the team. So as we kind of turn the chapter on this calendar year to next calendar year, domestically, we have the very best value proposition, more faster than our primary competition. We have this great new feature, which is getting great response in the field for picture, proof of delivery. We have Sunday service. We have brand-new digital capabilities called estimated date of delivery, which gives our e-commerce retailers greater accuracy on their delivery times, and we're getting really great feedback. And as you all know, our primary competitor has to manage through a significant labor conversation. So, we're going to come out of this peak very, very strong, and we are very confident in the momentum that Jill and her team are building in January. The same is true as we look into Europe. We have got quarter-over-quarter momentum. We've got three primary lines of business that we sell. In the domestic, we are optimizing. From a domestic perspective, we are there for the profitability of international and we have opportunity to optimize those networks and put some volume in the domestic networks and service is excellent in the domestic networks in Europe, and I'm really pleased with Karen and the team there. From an intercontinental perspective, we have a product called FedEx National Connect Plus, and it has done really well for us, and the team has continued to get the right business from Europe into the United States. And then from an intra-European perspective, that has been where we're challenged. But I'll tell you the brand has done a lot of hard work for us. Customers want to do business with FedEx. And quarter-over-quarter, we've seen service improvement. And with that, we have seen our pipeline and the confidence grow, and I believe that you will continue to see quarter-over-quarter improvement out of our European division. So yes, I'm looking forward to January, and I think we have the best sales team in the business to go and execute the plan I just talked about. Maybe just a follow-up with Brie. Can you talk about your confidence in getting that high capture rate from a domestic price perspective? And how you're going to balance that with our relation and the declining volume environment? And maybe you can talk a little bit about competition. And if you think there's a room to see more of that creep in here as more packages go that are lighter weight and shorter distance and the e-commerce growth you continue to see? And then separately, you mentioned the team's negotiation. I would really like to hear more about how you're approaching that both in the near term to make sure that you're able to protect your own service and longer term, if that presents any opportunities to gain share? Yes. So from a pricing perspective, right now, we do anticipate a high capture on our GRI here in the United States and around the world. Our GRI was 6.9 in the U.S. And it's about that around the world, a little bit higher in some places, a little bit lower. With the inflationary environment, most customers understand the need for a high GRI. That being said, I really pick out the team focused on two things. One, as I mentioned a moment ago, is differentiation. We command a higher yield when we have a better service and a differentiation and the marketing team is very, very focused on executing that. So we can command a higher yield in the market. Two, as I talked about in June and then I also talked about the anomaly price detection engine, we are building new capabilities to make sure that we align cost and price really closely, and we're continuing to build new features out this year, which will also help us get a lift from a revenue quality perspective. We want to be really, really balanced. We also acknowledge that some of our customers are going to have to choose our deferred portfolio, and we're working really hard to get the cost and the margins right in that product. As far as how we're going to handle the negotiations, we're going to do it professionally and with grace. We want to bring customers on that want to do business with us for long term. And so of course, for our target segment, small business, health care, B2B, we want them to be prepared. We want to protect, first and foremost, our loyal base right now. And Jill and her team will have really thoughtful conversations with those customers and make sure that they know we are here for them if they plan ahead and they want to do business with us in the long term. This concludes the Q&A portion of today's call. I will now turn the call back over to Raj Subramaniam for closing comments. Well, thank you very much. And I'll just say in closing that our team is moving with urgency to accelerate our ongoing transformation. We have made strong progress to date, and we'll build on this momentum as we move into the back half of the year. We all know there's a significant opportunity ahead, and I'm very confident in our team's ability to execute.
EarningCall_1469
Good morning. My name is Lisa Gill, and I'm the healthcare services analyst with J.P. Morgan. It is so much fun to be back in the big room again this year. It's been three years since we've been live. So, I am incredibly happy to have with me this morning CVS Health. With us today is CEO, Karen Lynch. Karen will kick off with a few slides, and then join myself and CFO, Shawn Guertin, for a fireside chat after her presentation. Thank you, Lisa. Good morning, everyone. It's a pleasure to be with all of you today, and Happy New Year to all of you. I'm going to provide an overview of CVS Health, a little more detail than probably normals for those of you who may not be as familiar with CVS Health, and then, for those of you who are familiar with CVS Health, it'll be somewhat of a refresher. Before we get started -- I have to click up, I'm obligated to give you our cautionary statement. Obviously, this presentation contains forward-looking statements and uses non-GAAP measures. So, I would just encourage you to consult our SEC filings. So, let me talk a little bit about our company and give you a perspective. As a company, we have over 300,000 purpose-driven colleagues that are driving the improvement of health across America. At the end of 2022, we expect to achieve over $300 billion in annual revenue. We'll have over $17 billion in adjusted operating income, and we'll generate between $13.5 billion and $14.5 billion of operating cash flow. As you know, we have three foundational businesses: our Health Care segment, our Pharmacy Services segment and our Retail segment. Combined, they deliver sustainable, profitable growth and deliver significant operating cash flow. Our strong performance in 2022 demonstrates the value that we deliver with our portfolio of assets, our deep healthcare expertise and our vast consumer touch points. At a glance, you can see that Aetna has over 24 million medical members. Caremark serves over 110 million pharmacy benefit members. And our retail business fulfills approximately 1.6 billion scripts annually. As you know, CVS Health is positioned uniquely to support an individual's health and well-being at every stage of their life. We finance consumers' health through our insurance products and provide them access to care through our provider network and as part of our Aetna and our Caremark businesses. We provide care delivery and health services through our health hubs and virtual care solutions, and we offer clinical programs for chronic conditions and medication adherence through our Aetna, Caremark and our pharmacy businesses. As you can see from this slide, we have the ability to impact the everyday health of millions of Americans. At CVS Health, our vision starts with everything to do with the consumer. Consumers, as you know, have changed dramatically their expectations around healthcare and they want healthcare to be delivered with the same convenience, access, and digital options that they have in every single aspect of their life. Our goal as a company is to become the leading healthcare solutions company by delivering superior healthcare experiences. Let me talk a little bit about our consumer reach, which is one of our single biggest differentiators. Across all of our businesses, we touch one and three -- one out of three Americans every single year. This translates into serving 100 million people annually. We have over 46 million unique digital interactions with our consumers, and nearly 5 million people walk into our CVS pharmacy every single day. It is our unparalleled proximity to and frequency of interaction with the consumer that is our single greatest advantage that we have in creating engagement. And as you know, engagement is the key to delivering lower cost and better outcomes. Our goal is to both expand and deepen our customer base and our market presence as we advance our strategy. I want to spend a couple of minutes just talking a little bit about the key areas that make CVS Health unique. We have an -- as I just said, we have an unmatched range of consumer touchpoints, more than any other healthcare company. As a company, we are one of the most trusted brands in healthcare in America. Our omnichannel health approach allows us to connect with consumers in more places and on their terms, in the community, in the home, and virtually. And over the last two years, we have consistently demonstrated our ability to innovate quickly and at scale, which is critical as you see the continuing pace of change in the healthcare industry. At our last Investor Day in December 2021, we discussed the bold shifts we were making as part of our strategy. These strategic initiatives are designed to ensure we achieve both near-term and our long-term commitments. Next, we'll advance our care delivery and health service offerings to include primary care, home health, and provider enablement. This also includes optimizing our retail business, which means reducing our footprint and transforming select store formats to serve as community health centers. Next, we continue to prioritize and invest in our omnichannel health, as I just described. We're also prioritizing the pharmacy experience given the significant opportunity that we have with 80 million pharmacy patients. We're also orienting our business using digital and technology strategy centered around the consumer. And we're optimizing processes in our company that drive value and creating an agile platform to sustain efficiency and lower cost. We're advancing our home health strategy by the potential acquisition of Signify Health. We expect this acquisition to close in the first half of this year. And as a result, we'll expand our services for our current customers, and we'll build on Signify's capabilities by linking them to our existing assets. We're also investing in our technology platform as one component of our health services strategy. We recently announced that we made a minority investment in Carbon Health, a cloud-based urgent and primary care technology platform, and we'll pilot the Carbon operating model in select CVS Health locations. And finally, our digitally-led engagement is a priority as we enhance our ability to deliver seamless and connected experiences. For many consumers, digital is the very first engagement point, and we've seen significant growth in our digital interactions with our customers. I want to turn now to our guidance for 2022. I'll start by saying that we've demonstrated strong performance across our businesses, and we've generated very strong cash flow. Yesterday morning, we issued an 8-K, where we highlighted that we expect to be at the high end of our full year 2022 adjusted EPS range of $8.55 to $8.65. This performance creates strong momentum as we head into 2023, where we continue to expect adjusted operating EPS in the range of $8.70 to $8.90, which at the midpoint represents high single digit growth off our 2022 baseline of $8.20. We'll discuss our full year 2022 results and we'll be issuing our detailed 2023 guidance at our earnings call in early February. Until then, let me just spend a little bit of time looking at our headwinds and our tailwinds. In our Health Care Benefits business, which, as you know, is diversified across our Medicare, Medicaid, and commercial businesses, this business is positioned to generate sustainable mid to high single digit adjusted operating income growth. As you know, Medicare is a strategic growth area for us in 2023 and beyond. For the full year of 2023, we currently expect our Medicare Advantage enrollment to be in the low to mid single digit percentage range. This result was due to a highly competitive open enrollment period, but we had strong sales in our D-SNP plans as well as in our Group Medicare, and we continue to project Medicare Advantage growth for the remainder of the year. Regarding our stars ratings, as discussed last quarter, our national PPO contract fell to 3.5 stars after nearly a decade long track record of performing at 4 stars or better. We have a strong history of delivering affordable, high quality plan benefits and a commitment to continuous improvement. We have the right actions in place to restore our star ratings by improving our CAHPS scores, which were the primary measure we narrowly list to hit our 4-star threshold. We also made progress in the last 60 days in advancing our efforts to diversify our national PPO contract, and have obtained the necessary regulatory approvals to move forward. This will enable us to more effectively manage our Medicare business in the future. In our commercial business, our growth trajectory is driven by our integrated benefit designs, and we do expect to grow commercial membership in 2023. Turning to ACA individual exchanges. We expanded our footprint in 2023 and now have presence in 12 states, with a total market eligibility of 5.5 million lives. The individual marketplace had another year of disruption, driving members to select new plans. We expect to add over 700,000 new members through open enrollment this year, bringing our total exchange membership to 750,000 lives. Moving to the Pharmacy segment. 2022 was another year of strong growth. We are well positioned produce mid-single digit growth in adjusted operating income over the long-term, driven by our industry-leading capabilities in cost management, service excellence and product innovation. We remain a market leader in specialty pharmacy. Our Specialty Pharmacy business is expected to generate top-line revenue growth of more than 20% in 2022, creating strong momentum that will allow us to continue to unlock the value to our customers and drive results in 2023 and beyond. As you know, biosimilars represent a future growth area, as a large pipeline of biosimilars is expected to launch over the next seven years, representing $100 billion of drug spent. These products will allow us to further demonstrate our ability to generate savings and deliver better outcomes for our customers and for our members. Finally, in our Retail segment, 2022 was a year of both the front store and pharmacy outperformed. In pharmacy, we continued to generate year-over-year retail pharmacy market share gains since the first quarter of 2020. Beyond the pharmacy, demand for health products and services continues to be elevated in our retail health locations, which play an integral role in supporting consumer's health. We provided health services to more than 5 million patients in our MinuteClinic locations this year and have administered over 78 million COVID vaccines to date. As consumers' health needs evolve, we continue to expand our health service offerings and capabilities. As I mentioned earlier, our foundational businesses make CVS Health a powerful cash flow generation engine. This is one of the most underappreciated assets of our business. The strength of our cash flow accelerates our ability to achieve our strategic vision and enhance value to our shareholders. So, let me talk a little bit about how we're deploying capital. We've been very clear in the three strategic areas where we plan to deploy capital: home health, provider enablement, and primary care. Specific to home health and provider enablement, we are advancing our capabilities, as I mentioned earlier, as the potential acquisition of Signify Health, which we expect to close in the first half of this year. Together with Signify, we'll have a strong foundation for developing new products consistent with our payer-agnostic approach. We'll continue to work diligently to identify additional assets, including primary care capabilities that will complement our foundational businesses and further advance our strategic vision. As you think about our long-term adjusted EPS growth, there are two components. The first is the value driven by our foundational businesses, primarily from high single digit growth in our Health Care segment and mid single digit growth in our Pharmacy Services segment, and an adjusted operating income floor of $6 billion in our Retail segment. In the aggregate, we expect these foundational businesses and cost efficiencies to drive approximately 7% to 8% of long-term adjusted EPS growth as well as strong operating cash flow. The second component of our long-term growth comes from contributions generated by the assets that we acquire as part of our capital deployment strategy. We're able to create synergies to accelerate our foundational businesses and the opportunistic return to value of our shareholders. CVS delivered strong results in 2022, and we continue to drive to become the nation's leading healthcare company. In 2023, we will deliver strong results from our foundational businesses as we focus on operational execution -- excellence and execution. We will continue to make excellent progress on our strategy, and we're so excited about the potential ahead for our business. Thank you. I think one of the themes that you and I have been talking about the last few years is value-based care. Something that I think everyone in this room appreciates that it's been talked about for 20 years, but I think we're finally having the different tools and technologies come together where we can finally start to see value-based care really make a difference. When I think about CVS, you're incredibly well positioned to capitalize on this broad suite of assets you have, clinical capabilities, ability to have that patient engagement, that face-to-face interaction, to really truly improve outcomes. Since we last spoke, can you maybe just talk about where you are on this value-based care initiative? We talked a little bit about Signify Health, but what other assets do you potentially need to be able to really drive that strategy from a CVS perspective? Yes. So, you and I talked a lot about value-based care. And clearly, we've been evolving value-based care over a number of years. It is important as the future of healthcare to really have engagement of providers and payers to really improve sort of health outcomes for consumers. As a company, we've been -- it depends on your definition of value-based care is, right? But as a company, we have a significant amount of our contracts through the Aetna plans already in value-based, some form of value-based care. But as we think about the future, we need to kind of swing that pendulum where it's more of a kind of risk adjusted value-based care arrangement. And Signify, obviously, through Caravan is one aspect of that, bringing us that ACO provider enablement, really developing risk. If you think about where the market may be headed, and Shawn and I talked to you a little bit about this yesterday, the government really is pushing on Medicare fee for service and driving value-based care there. That gives us another opportunity. But our entire strategy is clearly premised on our ability to drive value-based care, particularly in the government segment. And I think that's where you're seeing us really kind of focus our assets and really continue to elevate our contracting relationships in our Aetna business. And also, we have the opportunity in our pharmacy business as well. We're starting to think about value-based care in different ways. We have our Transform Diabetes program that gives us that kind of a foray into value-based care. So, we're really excited about the potential opportunities there as well. No, I would just go back to something you said at the beginning, Lisa, which I think is important. This idea has been around for a long time and it hasn't gone away, because it's a good idea and it is the right idea for the future. But, obviously, something hasn't been there, right, to make it work. And I think to your point, there is an alignment at time -- at this time, I think, of a lot of things. But when you think -- we've known for a long time on specific conditions what needed to happen to actually get better outcomes, it's always been about engaging the patient in that. And when you think about our proximity to the customer geographically, the frequency with which we naturally interact with that customer across multiple dimensions, the convenience that we can then bring to those interactions, I think that's going to be a real winning formula for us to unlock engagement. Yes. But I think we are learning. I think it's a very fascinating thing. We're really learning that some of the things to do that actually can kind of alter behavior in a positive way, we've really used the financial club for a long time to try to affect that, but convenience is really kind of a big unlock, I think, in this area. And engagement, because I think that's the critical part, and that's what we've been talking a lot about. You just heard me wax poetically about engagement. So, I think that's the key to unlock here. Putting a focus more recently on soft factors around things like health determinants, right, and we think about how important that is. Can you talk about social determinants of care and how CVS fits into that, and really how you can play a role going forward? Yeah, we've had a long-standing commitment to -- kind of addressing the social determinants of care, because you we know it's not -- health isn't just about the engagement with the provider. It's about all the other factors, including housing and nutrition. CVS Health, we invest in housing capabilities. We have, what we call, health zones, where we wrap around employment opportunities, access to nutrition. We have a very long-standing commitment to Project Health, where we bring vans into communities so that we give people the ability for screenings and then help them find and engage other ways to access care. So, it is core to what we do. It is core to improving health in America that we really think about the -- all the other factors of health that if you're not getting the right nutrition, if you don't have the right housing, if you don't have a job, you're not worrying about your health. So, we really need to make sure that we're wrapping all of those social determinants of care, and it's core to what we do and how we think about. As a matter of fact, we just brought in a new Health Equity Officer. And she's helping us think about -- if you think about how to lower cost of healthcare, you've got to address that, and she's helping us. We're focused on two areas, with health equity, women's health -- actually, three: women's health, behavioral health, and cardiovascular improvement for women. You touched a little bit on Signify and the fact that this is helping to expand your value-based care strategy on one side, your home health strategy on the other side. Can you maybe just talk a little bit more about how do we think about Signify? And then, the other question we get a lot is that two of the larger customers with Signify are two of your larger competitors, Humana and United. How do you balance that? Yeah. Let me start and I'll let Sean add, but let me address the balance of our two big competitors at our customers. I think as we think about the industry, we're all -- what's the word you used yesterday, [indiscernible], we're all kind of working with each other in, and we're all kind of customers to each other. And I think it's important that we all operate. And Signify provides an incredible service in home health risk assessments, return to care, being in the home is where healthcare -- the future of healthcare, and those customers, and I've had conversations with both of them, value that asset in a very big way. And we've committed to them to be payer agnostic, and I think that's just how the industry will evolve over time. The second thing that Signify gives us is that Caravan asset with ACO enablement critical to value-based care, critical to improving it. But we expect, as I said earlier, to close in the first half of the year. And this is the first leg of the stool of our longer-term strategy and really driving to value-based care. Yes. No, I think that captures the essence of it. It's obviously an accretive deal for us. And I think importantly, even beyond what it does today, it's the platform that it gives us for the future. And when you think about our strategy, I think all good strategy is premised on powerful trends. You talked about value-based care at the beginning is one. I think the desire for care in the home and the home as sort of a [indiscernible] of care is one of those trends. And that's not just personal preference, that's what's happening technologically with the ability to treat people in the home for different conditions. So, I think that is a really important long-term trend that we'll continue to build on sort of post Signify, but Signify gives us this great platform to step into that space and we have 2.5 million customers they interact with every day in the home. So… I think since your Analyst Day in 2021 nearly every quarter, I've asked about primary care and your thoughts on potential acquisitions in primary care, how you think about this strategy in primary care. Can you give us any kind of update today as to your thinking around primary care? How important an asset or an acquisition is? Clinic model versus we've talked a lot about physician enablement. So, maybe just talk about the way that you're thinking about the entree into primary care. Yeah, what I would say, I think, we're very committed to that longitudinal relationship with customers. We believe that over the long-term having that -- primary care wields significant influence over the entire healthcare continuum and we believe it's an asset that we want in our portfolio. What we've been very clear about, we want to make sure it's the right asset at the right time. And we continue to evaluate our options. And what we've said is, this isn't one and done. We have to expand into other areas to continue to evolve our strategy like in-home health, we will. Yeah. And I think the primary care, I think, we've known for a long time, while a small piece directly of overall cost has had an outsized impact on managing overall cost levels, right? And to some extent, it's been the economic models that have been lacking, not -- sort of the same idea on VBC, but it's key to VBC, right, and value-based care. Now, to your point, the way we're positioning for that is there could be an owned capacity through which we deliver that and get benefit, but there can also be an enabled capacity. And I think we see ourselves for a variety of reasons playing in both spaces, both enabling that transition to value-based care for non-owned clinicians, if you will, and then having our own clinicians where we think that makes sense. At least, I think it's important to understand as we think about primary care, which is kind of a continuum. We have our retail health capabilities, which is episodic care. We -- you heard me talk about Carbon today, that's not kind of primary care, but it gives us another kind of avenue for engagement. Then, there's kind of the relationship with the employer segment and then there's that relationship with the government segment. And that's really when we think about value-based care and kind of this primary care, that's how we're thinking about when we've been pretty consistent about that. You talked about cash flow a year ago. You talked about cash flow again today. Extreme amount of cash flow. And you talked that you did an ASR yesterday. So, maybe just talk about how you're balancing all of this, right? I think Karen had in her slide the talk about committed to the dividend, committed to continuing to invest in the business, right, but that still leaves you a lot of capital to do a lot of different things. Does this ASR preclude you from doing something near-term when we about a potential acquisition or some other kind of investment? Right. No. And the answer is no, not at all. And that slide that Karen had up there, I would say philosophically is sort of the steady state slide that would represent our philosophy on an ongoing basis. But in the near-term, the most important thing for this company from a capital perspective is to affect the long-term strategy that we're discussing, and to begin to change the positioning of the company as it goes from a sustainable earnings growth perspective, and we think care delivery is the big vehicle for that. That becomes -- the execution of that long-term strategy becomes the paramount mission for that. So, we thought, as we went to that, doing some incremental share repurchase. We certainly thought through making sure this didn't preclude us from executing that strategy. And as you've seen with the numbers, right, that we have plenty of breathing space. So, it was something where we thought that we could -- it was the right thing to do in the short run, but by no means did it compromise in any way what our long-term strategic vision is. Karen, you touched on stars for 2024 and the disappointment in some of the plan moving to 3.5 stars. Can you talk about opportunities to maybe mitigate some of that, especially since a lot of it is group MA is my understanding? And then, what is your anticipation around the impact on the individuals as we go into the 2024-type of open enrollment period? Yeah. So, as I mentioned, we narrowly missed that 3.5 -- that 4 star, brought -- bring us down because of CAHPS. And there's a lot of opportunities for us to drive actions to improve our engagement with consumers and we have a lot of actions underway. We also mentioned that we have an opportunity to contract diversification. I just said that we've got the necessarily regulatory approvals to move forward with that contract diversification. So, we feel pretty confident about our ability to mitigate some of that risk going into 2024, which is different. We've done a lot of things in 60 days. So, we're well down that path. Just will there be an impact when we think about 2024 open enrollment given where we are in the stars? I mean, again, you talked about the approval that you got for the group, but how do we think about the individual? Yeah. I think, we're going to work really hard with our distribution channel, with our benefit designs to mitigate that risk. I think for individuals, they look at stars and so we're going to work exceptionally hard at making sure that we have the right distribution, the right marketing capabilities, the right outreach, and the right benefits, because it really all does come right down to the benefits, and we'll be evaluating -- it's hard to believe it's right around the corner, that we'll be evaluating those benefits and we're going to work really hard to improve that. I also want to mention, although we were disappointed in our Medicare enrollment for 2023, we have grown our D-SNP, we are growing our group Medicare, and we do expect to grow for the remainder of the year. And I think that you had mentioned to me earlier that you also had good retention, which is also very important for many of you in the room, right? Shawn as we think about the value of that member, having that same member come back the next year is generally better profitability since you better understand that member. Is that correct? Yeah, that's absolutely right. So, the new members -- a lot of times, the new members are less profitable than average. So, while I'd still rather have the members for the long run, that mix of having better retention and sales is actually a positive in the short run on the margin dynamic inside the book. So -- and I also think when your retention is better than expected, it does speak to the service levels, the value in the product, the value in the benefits and things like that. One of the big things that we're looking at right now, right, is RADV that will come on February 1. It was supposed to come in November. Can you just give us your perspective on what you're expecting on February 1? I know, Karen, you've spent some time in DC and have some kind of insights there as to what potentially could happen from a managed care perspective. Yeah. What we're hearing is that we do expect that there will be some type of RADV rule coming out. It's not clear to us if it will be what is the kind of proposed today. So, we're hopeful that maybe they'll have -- make some changes. But as you know, the retro act -- kind of retrospective adjustment, we're not supportive, we're not fans of. Clearly not using the fee for service adjuster, something that we have very strong concerns about. And then, the extrapolation piece of it is another concern. So, when the regs do come out, we'll evaluate it, and we'll work with the industry to address whatever needs to be addressed with the RADV rule. The other things we've tried or trying to understand around Medicare Advantage is just your expectation. I mean, the rates have been improving nicely in the last few years, especially compared to what they were historically. What is your expectation for rates for 2024, which we'll hear preliminarily, right, kind of around the same timeframe? Yes, I guess, I would, in a more general sense, I mean, I remain and I continue to remain very bullish on Medicare Advantage as a program. Having said that, it's, obviously, such a large budget item. I think it's always going to come under some kind of fiscal consideration from year to year. We've been in a period of exceptionally good rates. So, it wouldn't entirely surprise me over time to see some of that change. Now, it's a very interesting question vis-a-vis the inflationary environment that we're in right now and how that factors into all of the formulations. So, I'd hesitate to make a 2024 prediction. But I do think over time, it's one of the reasons why I think you really always want to be focused on sort of delivering better outcomes and lower costs in this product so that you are prepared if that eventuality comes to fore, then you're better positioned or as best positioned you can be if you can really deliver sort of that lower -- the better outcome and the lower cost. We didn't spend a lot of time talking about retail today, but CVS has really been on the forefront from a COVID perspective with vaccines. I would anticipate that you probably have seen good volumes because of the triple threat of RSV, COVID, as well as the flu. Can you talk about what trends that you saw? And then on top of that, Karen, just looking historically at flu vaccination and COVID vaccinations that you've seen more recently, anything you can talk about as far as trend goes there on the vaccination side? Yeah. So on, RSV, flu, COVID, we saw spikes coming in in December. Obviously, we have the balance, right? You've got the impact to the Health Care segment. You've got the positive on the Retail segment. We saw improvement in cost in cold, and we did see our vaccinations for flu kind of elevate a little bit in the latter half of the year kind of meeting our overall expectations. Our expectation on kind of flu and COVID, as a company, we have been sort of the go-to-choice for vaccinations. And our thinking is we'll continue to be that consumer choice for vaccinations and positioning to deliver that. And I think it's another engagement point, right? And it does demonstrate you get the flu shot, you get the COVID shot, you have lower outcomes, you've better improved health outcomes. So, it's important part of how we think about that engagement in the community and having that service in those local communities. One of the things that you mentioned in your presentation was on the pharmacy services side, the PBM side of the business. And that's biosimilars. The $100 [million] (ph) worth of biosimilars coming in the next seven years. I think for many people that know Caremark know they were the first specialty pharmacy company in the country. They've done a great job at really converting people to generics and even to early biosimilars. As we think about this next wave, what do you think are the incremental opportunities? Do you think that, for example, like a Humira, do we need to have interchangeability? And what's the margin opportunity when we think about those? Yes, I think -- and I'll have Sean addressed sort of the margin update. But I do think when we think about the biosimilars that gives us a big opportunity. And you said it, Caremark has been the leader here. And I do -- and I think interchangeability will help. We've had experience in that. We've demonstrated our ability. But at the core of what we do, it's to drive the lowest net cost for our pharmacy benefit members. And that's how we evaluate how we put things on the formulary, the contracting that we have with our manufacturers. And that's what our goal is. And we have demonstrated that time and time again. And it is a big opportunity. And I think that that's -- I talked about the future of the pharmacy segment that's going to benefit for us. Yeah. And I think this is similar -- and to your point, we've seen some of the early biosimilars and special generics and we've seen this play out. And it's a real win-win proposition in that we get much lower cost ultimately to the consumer for this, and we can actually increase our margin sort of as we go through that. And I think as we think about PSS over the next few years, we think this might be the difference between this being a mid single digit business to maybe pushing up into the low end of sort of high single digits. But it maybe moves it up in the range because of the multiyear opportunity. And I think the thing here is I think there's less question sometimes about whether this is an opportunity, but the timing of it, right? And when some of these things, the timing of which some of these things come to market and then to your point about the ability to change to the new agents and all of the factors that are involved in that. We have about 90 seconds left. And generally, we like to end these sessions with, when we sit here from a year from now, what will investors appreciate about CVS that you don't feel they appreciate today? I think there's a couple of things. One is that we have 300,000 colleagues that are committed every single day to improving the lives of Americans. I think the second thing is that the powerful cash flow generation that we have as a company. The third thing I would say is that we'll continue to deliver our performance as a business and continue to execute on our strategy. And I think the power of execution as a company will demonstrate that as we go through the year and beyond.
EarningCall_1470
Good to see you. Sorry. I have a bad cold, but i don't have COVID. So you don’t -- got tested. So you're okay with that. So before we begin, I'm just going to remind everybody that Bharat's comments today may include forward-looking statements. Actual results could differ materially from forecasts, projections or conclusions in these statements. Listeners can find additional details in the public filings of TD Bank Group. So with that out of the way, the topic of the day has been capital with the changes in the DSB regime and in your situation, we have the closing of a couple of acquisitions coming up. So maybe we can talk about how that might impact your capital position and whether or not you see the need for raising equity here or maybe potentially if the DSB is raised later on this summer? I think, I'm trying to remember the exact number, but we closed off a year at what 16.2%, 16.2% Tier 1 capital and I think when we talked about post acquisitions, we said, we expect to be comfortably above 11% after closing both the transactions. Feel that we have enough capital levers. Some of it is well known things like the -- invoking the drip discount. We've also talked about optimizing RWAs through our investment portfolio. We have structures out there like our evergreen credit card, ABS, and the Cowen acquisition, we pre-funded it essentially through equity by selling a bit of a Schwab stake. So when you look at it, those are some of the examples of capital levers that we have. We feel pretty comfortable with the state of our capital position and if traditionally the bank's history is prudent capital management, that's been part of our brand, part of our whole market TD. So I feel comfortable where we are on capital. We generate good access capital 15 basis points to 20 basis points a quarter. So if you kind of do all the math, puts and takes here or there, feel comfortable as to where TD is placed with respect to capital. DSB is interesting. DSB obviously has an influence on -- as one of the inputs is why we think about it, but not the only input. We talked about being comfortably or 11% before DSB was moved. So that's how we thought about at the time. I think with the DSB, if things turn out to be worse than what people are forecasting and we get into a major slowdown, than the -- and osprey had signalled this that the way they look at DSB is, they would drop it at that point, if things turn out to be from an economic perspective. So we'll see how things turn out, but I think overall, we feel comfortable based on our own situation, how we are forecasting the next year to play out. I think last quarter end, I talked about as to where we feel earnings will come out for the current fiscal year. If you add the two acquisitions, the profitability from those, if you look at interest rate tailwind because if you annualize some the rate increases as to what it does to TD given the type of businesses we are in, look at some of the volume growth, particularly in areas such as credit cards where we are geared more towards luxury and travel, which is come back quite smartly post the pandemic. Now, things could change quite dramatically if things go sideways in the economy, then of course, it might be more difficult, but with all those things working out, we feel comfortable that we could be well within our earnings target growth of 7% to 10% and there's a chance we might exceed it. So if you kind of add all those numbers up and you say, well, where the DSB goes well, wherever it goes, it'll go, but we think we have a lot of levers to manage around. One of the levers that you mentioned, you mentioned the drip, your organic capital. You didn't mention the Basel reforms, Basel 4. How is that going to affect the year for TD? Is that a factor we should think about as well? I said the headline on Basel 4 it's a manageable situation for us, but let's -- there's various moving parts on that. So an operational risk under Basel 3 and now Basel 4, I don't know whatever we call it, that's going to be probably a negative item for us because retail revenues would be viewed similarly to other types of revenues. We have a large retail base. So, that'll be a negative. There will be a positive on the credit recite because a lot of the advanced approaches would apply, probably slightly negative on the market risk side depending on the fundamental review of trading books as to how exactly when that gets invoked. But on the other hand, there might be a positive when Schwab stake and then somewhat unknown and we are doing a lot of modelling on this is the variability that will come from First Horizon, but the reason I give you all those headlines is tells you how many moving parts there are is how they could work out, but overall, we've done a lot of work on this. We think it's a very manageable situation for us. So in the end, it doesn't sound like much has changed sort of business as usual over at TD and managing capital going forward now with a wide DSB range, does it necessarily say to us that from an acquisition point of view, future acquisitions are facing a higher hurdle rate, now with the hierarchical requirement. Does it change your appetite for what you would look at, given that you're getting Cowen, would you, for example say, we don't need to acquire any more in capital markets because of the capital constraints or so on and so forth. So just trying to dig into whether or not this, sort of, change in regime so to speak on the capital front changes anything for your capital deployment going forward? I think, of course regime matters, but it is importantly for us is I think I've been saying this for a few years is we think of capital deployment in a particular way which has been consistent and I don't think changes. Do we -- it starts with do we have enough capital to support our organic strategies, critically important to us, and the answer is yes. Do we have any capability gaps that we may have to use capital either to invest or to buy because we want to fill that gap -- capability gap out. Do we have enough capital from an opportunistic perspective, should there compelling opportunity come up. I think Aeroplan is a good example in our sort of history here where that was a bit of a surprise and it came up and we were there because we had not only the capability, but the capital to take advantage of that. It turned out to be a terrific situation for TD given where we've come along in that business. And so we go through that framework and said at the end if we have and do we have any major acquisition aspiration in the market because we might have to grow certain sectors or not and if all those turned out to be, there's no opportunity, would we buy back our share? So that's how we've been thinking about it. Has that changed and in dramatic fashion. Of course, and I don't want to underestimate the capital regime. Of course, the economy and the state of the environment has a lot of influence in each of those components. So yes, the capital environment has an influence, but generally we've been talking about how we manage the bank through any cycle and capital discipline, capital prudency has been a core part of how we tend to think of the bank and so that has not changed. Now regarding future acquisitions, what the acquisitions that we announced and I said it when we announced them, they met our four criteria we look at. Number one; was it strategically compelling? Both in First Horizon and Cowen again say yes. Was it financially attractive? Both these transactions were financially attractive. Were they within our risk appetite as in time has shown that yes, they were within our risk appetite have continued to be in our risk appetite and number four, critically important to us, are they culturally aligned? So Darko, even with all the clouds that are in the economy and capital regime, if another situation have to come up, that hit all those four criteria, of course we would look at it seriously. So does this make sense, because those don't happen very frequently that you meet all your criteria. So I am not saying we unlikely we do anything until we close these transactions and feel comfortable, but never is a long time. Okay. Fair enough. Thank you. You mentioned it, so we're all curious closing, is there any updates you can give us on these deal on Cowen or First Horizon or on your expectations on closing or any other update you can provide given the environment that we're in? See on First Horizon, there were certain aspects that needed to be done. So the shareholder of vote -- the First Horizon shareholders had to the vote on the transaction and that did take place and folks who decided to vote 99% of them decided to vote in favor. That was great. There was a public meeting and organized by the regulators and that went pretty well. I think, there was a lot of support among the community groups with TD's application as to how TD is viewed in the markets in which we operate in the United States. So that was very good. Another aspect in the US that has become pretty common is agreeing on a Community Benefit agreement and that we are negotiating with the various groups that are stakeholders in that part of our arrangements and that's going pretty well. We haven't signed one yet, but it's going pretty well and I expect us to get there on that. And the final one is the regulatory approvals by the major agencies in the United States. Now that is an unknown, the US, the latest deals seem to take longer than what it used to. One deal that was approved took, I don't know, 14 or 15 months or something like that. Another deal that was announced approximately two and a half, three months ago before our deal got announced, we are into about nine or 10 months into our I think end of February when we announced First Horizon with a deal that was announced couple of months, two or three months before ours is not yet been approved. So given all that we -- last quarter, I said that instead of original expectation of closing within the first fiscal quarter of this year will be the first fiscal half, which seems to be appropriate, given all the other stuff that's been going on. So that's our expectation on when that gets done. On Cowen, again the shareholder approval, Cowen shareholders approved it overwhelming. Again, it was 99% of people who voted. A couple of approvals are already in hand and so that we are expecting. I think it's the first calendar quarter of this year to close and so that's our expectation on both these transactions. Okay. Thank you. That's helpful. Maybe switching gears a little bit talking about Canada's situation with housing, price declines, large increases in mortgage payments for a cohort, you have a large mortgage book in Canada. So maybe you can walk us through how you view the vulnerability in the sense how much of your book faces increased trigger payments? How many of them will be facing a significantly higher payment this year and next and are we worried about something like how big of a part of that -- of your mortgage book is facing what I would consider a difficult situation of 30% or higher increase in mortgage payments? Yeah. I know there's lots of discussion on this. I think, few people before me talked about this as well. So it's a common theme and to be expected given the environment we are in, we've not seen rates go up at this pace and so much over the recent past. So obviously, it's a right topic to be focused on, but I think it's important to keep it in perspective. Look back many, many years, as to what's been the experience on Canadian mortgages, through very difficult periods and you look back at least from a TD perspective, if you look at our historical situation on Canadian mortgages, I'm not even talking of losses. I'm talking of impaired formations. It has been in the low single digit basis points perspective. historically, if I'm looking at multiple years here and you say why is that? Why does this asset class behave so well through circumstances and it starts with a basic problem that we have in Canada. This year, I think everybody saw that nearly half a million new immigrants entered Canada. In Canada, we build homes, new homes to the tune of 200,000 homes to 250,000 a year. So every year there's a chronic supply problem that gets worse. So even if magically, we flick a switch and all of a sudden, supply of new homes goes up to 0.5 million think of the backlog that has to be cleared. So you start with the premise as to what are the fundamentals of this business? And then from a TD perspective, we are a huge scale player, but a vanilla player. We are not an alternative mortgage player. We don't play on the margins. We are not a subprime mortgage provider, and that's what we do. Thirdly, less than 1% of TD's mortgages are uninsured, have a bureau score of less than 650, and where loan-to-value is over 75%. So let's talk, from a basic quality perspective is the quality of the book. Then you say from a macro perspective, so our estimate is through this rate cycle and probably have more to come that approximately there have been increase in mortgage payments of $200 per month to $600 per month, like if you look at from a modeling perspective. And against that, this excess savings that have been built up through the pandemic to the tune of 30% of excess deposits still compared to pre-pandemic levels. So you're looking at a long period before all those things get exhausted. Then you say, "oh my God, there might be a big problem". And even when you get there, you have to think about that somebody has lost their job and loan-to-value is over 100% before you start seeing major problems. So you say, all right, what scenario can you see where loan to value is over 100% for a bank like TD that is not in the subprime mortgage business or alternative mortgage business where somebody has lost the job and excess deposits have been run off and they don't have other levers to pull back on expenses. So there are a lot of scenarios at play, but so I'm just trying to give you a perspective as to how I'm thinking about this business. Of course, can there be a bump? Of course, we are in that business and we manage that. And that's why every quarter, you ask Ajai and you say, "oh, yes, of course, Darko am building this, and he should". But historically, this is how this asset class has behaved and do I see a dramatic shift in the behavior? I don't. Do I see a bump? Of course, I do. We would not -- I shouldn't be paid what I'm paid if we can't manage through bumps. And that's how we are looking at it. It's a great business to be in. It's a great asset class. And final point is that, in our case, we've taken lots of questions from a lot of our analysts, including you, Darko, that I think it was six months ago, eight months ago, how come we are not growing as much as the others? So where we are consistent underwriters through a cycle. That's how we kind of manage this business, and that's been the historical sort of record for us in that business. So feel comfortable with the quality of our mortgage book, how the asset classes we have historically, how we see the future playing out, the support that there is there against this asset with excess savings, etcetera. So feel comfortable as to where we are. So asset -- so the mortgage asset class, we've covered that. So the next sort of segue where this takes me is, when I look at what you guys use for your forward-looking indicators, it doesn't look that bad. Your unemployment rate base case scenario goes up a little bit in 2023. And yet what I'm hearing is mortgage payments have risen, they might dip into their excess deposits. It sounds like there could be a drag in the economy. So, okay, we won't have any defaults in mortgages. But we'll have a drag on the economy. So how do I think about your forward-looking indicators not necessary showing a recession, not necessary showing any sort of bumps or bruises? And how do I think then about your reserves that are on trace sheet relative to what I view as a relatively okay forward-looking indicators and many people in this crowd think there's a recession coming? Can you… I am not suggesting there's a 100% chance, there's no recession. When rates go up so much is there a slowdown to be expected? Yes. But on the other hand, the job market has been remarkably strong and continues to be strong. And I think one aspect that I am sure history will write a lot of books on this is impact on the economy post pandemic. With such an event and the level of fiscal stimulus that took place, the level of monetary easing that took place as to how long does it take for that to play out? 1 thank time will tell. So am 1 saying for sure that this is going to be just a benign environment? No, absolutely not And that's why everybody is looking at what happens. But the part to watch in employment and if you want to look at losses, If you want to look of what happens in that's the indicator as to what's going to go on. Now each of these asset classes has nuances like I talked about supply of housing etcetera and even if we don't get to a recession, much slower growth is going to feel the a recession I'm sure there are a lot of sectors right now. I talked to a lot of clients are feeling they're already in a recession. So I don’t want to undermine the environment here, but is it going to be a deep recession like what we had post the global financial crisis for a while, around the world, I'm taking perhaps Canada we did not feel it as much or what folks are testing in March of 2020 as to what because the pandemic, when there is a forced lock down? It'd be more of an interest rate caused recession. And if you want to look at what modelling is out there, would there be a showdown? Of course, there's going to be a slowdown and all of us are prepared for that and managing through. And frankly, our modelling in showing that's how we will manage the bank through. But are we seeing a depression here with some of the questions you were asking me say, 'Oh my God, the world is coming to an end" We don’t see that. And so one of the tailwinds you've had at your bank has been ret interest margin expansion, fairly strong, NII growth. And in fact, when I look of consensus estimates, looks like you've got very high growth expectations for this year in a year where PCLs are normalizing, in other words, rising. So in that environment, are we getting carried away with net interest income growth for TD? What's your view on that? Is that going to be the big swing factor that-on EPS this year? Is it -- our NIM's peaking? How should I think about your net interest income growth? And I'm going to say, excluding the acquisitions. Yes. So firstly, just to folks might feel that we position the bank to be interest rate sensitive that that is the core objective of the strategy. I think the important thing to note is we are interest rate sensitive is an outcome of the strategy we run at the bank. We are a huge, what I'd call, non-interest rate sensitive deposit gatherer and what does that mean? Huge checking bank, huge transactions, accounts bank. And the outcome of that is makes us on the deposit side more interest rate cone because those are non-rate sensitive deposits and when rates go up, beta on that is zero, and therefore, your margins expand and that's the outcome of the strategy that we run. So I think important to clarify that this is not that, less position the bank because Barrett has a view as to what rates are going to be 4'O clock in the morning lightning bolt, and here we are. And that's not the way it is. This is how the strategy is designed and that's how the bank is configured. So as rates go up, we benefit because of this strategy that we are running. And so the rates have gone up and you've see what's done that to NII and NIM, etcetera in the bank and as rates increase even more, who knows? They don’t know what is 100% clairvoyant or we know exactly what work out. As long as rates go up, of course, our margin will benefit from it. And we also have a tailwind on annualizing some of the rate increases from last year. So that's a benefit here. But you pointed out what are the offsets against it? Well, the offsets are there might be a slowdown in the economy. So volumes might suffer. Mortgages are already slowing down. So that is to be expected and to some extent, welcome given where we are in the cycle. So that will be the offsetting part over there. So that's how we look at it and so look, I don't want to talk about consensus. That's what you folks do for a living, but we feel and 1 was quite clear with the guidance on warnings growth, given where rates are, animalization of those rates, the acquisitions, ignore acquisitions, but assuming that they happen. We're looking at warnings growth of more than our medium-term target and can things, this is forward-looking. So there's no guarantee it's going to happen. Could things turn out to be different? Timing of acquisitions could be different. The economy turn out to be much difficult than what we are forecasting. The geopolitical situation might turn out to be uglier than what it already is. So a lot of moving parts here. But overall, given the strategy we run, we feel there is, that's core part of our business model, more consistency and predictability in our earnings, and that's the reason I said what I did in December. Sounds good I'm going to take a look here at the questions that are -- actually the question is, what if rates fall but I guess that's back half question? It's a great question because I thought you would ask me that saying, do we see another alt of TD here. So that's interesting because it's not as if our margins go through the floor when rates were zero. It want too long ago, and we were doing quite well then too. So it's not as if we don’t have experience as to how to manage the bank in the low rate environment. We've been doing that for the past 12 years and why is that? So simplistically, the asset sensitivity on rates it's again, I'm simplifying and 1 want to quality that is you would think that all the banks are similar in mat side how much fixed rate loans we have versus others or whatever. The main difference comes on the deposit side as to what happens on non-rate sensitive deposit growth versus rate sensitive deposit growth? So non-rate sensitive deposit growth as you know and Darko, we've talked about it in our earnings call and one-on-one meetings and all that, that we tractor those deposits. So when rates fall by the time they work through our P&L there's time. There is -- it's not an instant thing that you drop away. And as rates go up, it helps you very quickly because not only the old tractors are repriced higher, but your new deposits are priced at a higher level because you're tracking at the higher level. On your rate-sensitive deposits, your beta works immediately, right? If rates drop, your deposit rates drop immediately. So that's the way to look at it from a -- when rates drop is to how it would impact TD? The pressure on our deposit margins will work through over a few years, whereas on the rate sensitive, it is not a small part of our business that's an immediate impact, but that's no different than any other hank. So it's a long way to describe how actually the TD's deposit book works because sometimes it's not well understood. And it's important to clarify that. But I feel that we've shown in a low rate environment that we are able to manage the bank with consistency and within expectation. Okay. We're running down a little bit on time and I am going to ask another question from the audience. But before we do, I think, I have on opportunity here because you're up here and you've got a large credit card book, you talked about Aeroplan, but it's much bigger than that and so one of the things that I wanted to ask with you being here is, is there's some work on towering the interchange fee here again in Canada. And not only is there supposed to be an industry led solution and then the government is suggesting. Hey, if we don't like that solution. We'll come up with our own solution. So in there any update you can give us on this process and can you give us your perspective on a bad outcome, let's say, if interchange fees are dropped significantly? How do you react? What does TD do? Think of the credit cant business, there's a business model attached to it, right and the convenience, the credit availability, the fraud management around it, all those aspects create a value proposition for the holder of a credit card, and the rewards critically important as to how what value you're providing to your customer. Attached to that value proposition is a series of costs and revenues and so, of course, if any component changes here, the value proposition has to change. So we'll see how plays out. Unfortunately, credit cards have been in the headlines for many years. It's not a new phenomenon. A lot of stakeholders that have a desire for certain costs to go down, but not the benefits to go down, but I think banks generally have managed well on how to adjust their value proposition. We had a change and interchange a few years ago, about three years ago or something like that and people thought, Oh my God, the whole situation might change quite dramatically, it didn’t because the value proposition adjusted to the new reality. So my hope is that we do come up with a sensible solution here. I think some of the objectives laid out makes sense for the small businesses. We also want to make sure that our small businesses are added in a particular manner and relative to some of the big retailers that might be out there. So we'll see how all these things play out; but overall, it's a business, business has cost and revenues attached to it. And if one of those components change, something has to change because that's how the business is run and managed. So I'd expect that to continue. Fair enough. I guess the concern would be that it would be a rapid drop in the interchange, and therefore, there would be a big change in the business model rather than the previous interchange drops which we minor and so I don't know if you can comment on anything like what they're talking about in terms of the degree of the drop? Hard to talk about specific discussions with various stakeholders and let's not forget, this is not just TD or the big banks. You got the networks that are in the middle of it. You've got various other stakeholders, various merchants, different sites of those merchants that are at play here. You've got the government having a say in it. So it's a multiparty situation that is ongoing. So time will tell exactly when we end up. But I have confidence that we come up with a sensible solution with the definitive view that if you pull one side, something else is going to get impacted: This is not like there are only one thing one side happens. If it happens like your speed at which something happens, something else is going to happen at speed as well to offset it. That's how the works. It is a business and businesses work on ensuring that the cost revenue ratios remain within sensible ranges. So maybe with that we can finish off the session, Barrett with handing over to you and just maybe you can provide us with your key messages for investors and shades for 2023. So notwithstanding firstly great to be here, Darko. Thanks for asking me. Notwithstanding the unpredictability of the environment, the volatility, high rates, high inflation, risk of a recession, I feel pretty good about TD going forward. If we look at our balance sheet, the size of our business, the scale, the market share we have the market positioning we have in various markets feel great, notwithstanding our size in Canada. We see huge opportunities for growth in our wealth business, in our credit card business. With the acquisition of Cowen, it helps our Canadian business as well, to a great deal on the capital market side. The US, what can I say? We are a very young franchise the First Horizon acquisition, highly complementary. They bring huge capabilities First Horizon on middle market banking, on commercial bonking, TD prolific on what I'd call very traditional products on the retail side, and we bring these banks together as to what we can do. We become the sixth largest domestic bank in the US without looking at the rest of TD and so feel great about that as to how we are portioned. And we've shown that we can manage the bank very effectively and very profitably in various scenarios, and our conservative risk culture, capital management bodes well given the uncertainty in this environment. So I feel very excited and again, thank you, folks for your confidence in TD.
EarningCall_1471
Excellent. Well, hey, I think it's still good -- good morning, everyone. Welcome to Day 2 of the Barclays TMT Conference. My name is Saket Kalia. I cover software here at Barclays. Honored to have the team with us from CrowdStrike. We've got George Kurtz, Co-Founder and Chief Executive Officer. We've got Burt Podbere, Chief Financial Officer. We've also got Maria Riley and Will Zelver in IR around here somewhere. There we go. There's Will. So just to frame today's discussion, we've got about 30 minutes together. Let's take maybe the first 20 or 25 minutes and do a little bit of fireside chat with the team which I know is going to be fun. And then let's make this interactive, right? If you got any questions, just pop up your hand. We've got a mic right around here. We'd love to make it interactive. So maybe all of that as a framework, George, Burt, thanks so much for being with us here today. Won’t be a conference without CrowdStrike. Guys, maybe clearly, all of us know the company. So maybe a good place to start just to level set for everybody is can we just maybe recap some of the key operational and financial highlights that you -- you guys were most proud of from the most recently reported quarter? Well, I think there's a lot to be proud of in 2 particular areas when you look at our free cash flow, record free cash flow of $174 million plus. And I always like to -- we talked -- Burt and I talk a lot about this is we've never been a growth at all cost company. And you look at our rule of 40 which is 83%, I think it was 83% on a free cash flow basis, a $2 billion-plus ARRs were [indiscernible]. So you look at that. And then obviously, everything revolves around customer. Our net retention numbers which we’ll give out in total at the end of Q4, were at record levels for the last 7 quarters in line with Q2 and then our gross retention, same. So customers like what we have. They want to buy more and we’re generating a lot of cash flow from that. Yes. The only other one that I'd like to highlight is the record non-GAAP operating income. That just speaks to some of the unit economics that we always watch and we're always on top of. We are not a company that grows at all costs. We want to make sure that we're handling the expenses responsibly and we've been doing that for quite some time. So we're excited about that, too. Yes. Absolutely, lots to be excited about there. Burt, like all of our companies here at the conference, right, a lot of talk about macro. Maybe you could just tackle a little bit of that from the last quarter. Can we just walk through some of the moving pieces there with the net new ARR? And maybe part of the question as well is, at what point in the quarter did you really start to see some of the -- some of those macro items start to manifest? Yes. So for us, we really had line of sight for hitting our expectations right until the very end of the quarter. Like the last 2 weeks, we saw a couple of things. First, big picture, we saw pronounced macro headwinds and it manifested itself in 2 ways. One was on the non-enterprise deals where we saw at the end of the quarter, we saw them push out to the tune of $15 million. And we saw sales cycles in that non-enterprise market increased 11% over the last quarter. Second place where it manifests itself is in structure for our enterprise deals, where we saw some of the enterprise folks have staggered start dates. We’ve always had staggered start dates but we saw an increase over the last quarter to the tune of about $10 million. And that’s -- and to be very clear what that is, is that if a customer has 100,000 endpoints that they want to deploy our workloads, they might do 50,000 in this quarter and 50,000 next. That would be one example. Another example is a customer buys 7 modules, whatever it is. And the sixth or seventh they might push into the next quarter. So that’s how that manifested itself in terms of actual dollars. Yes. So just to be clear on that, so ACV is there. It doesn’t convert to ARR until they start the subscription. That's right. That's right. So closed deals. Just a matter of meeting the -- being flexible with the customer which I think makes a lot of sense. Maybe you mentioned the non-enterprise part there, Burt, so maybe a little bit of a tag-team question. First, Burt, can you just remind us roughly how big is that non-enterprise or SMB or whatever you want to call it kind of part of the business? If I remember at the time of the IPO, it was roughly, call it, 20%. You correct me there if I'm wrong. I think the -- an even more interesting question though for you, George, relatedly, is you talked about how win rates in that SMB part of the market actually went up in the quarter. So I was wondering if you could just dig into that as well. Who are you winning against? And yes, maybe we start there. So when you look at the SMB market, it's something we spend a lot of time on, particularly with products like Falcon Go and even Falcon Complete because a lot of SMBs have high risk. They're using other technology, signature-based technology getting attacked and ransomed. And we've been able to swap them over to CrowdStrike. I think what’s important to realize that some super fragmented, highly fragmented market. I mean, you’ve got everybody and their brother in the SMB from all the traditional signature-based AV players to more of the next-gen folks like us. And again, we’ve seen a lot of success there in the product offerings but also in things like Falcon Complete because we can -- and I use this example, I -- Burt and I were -- we look at all the deals as they come by and there was a deal that came by. It was a $2,000 just pure AV credit card buy, right? Online, no touch AV. It’s all flight. It went into the inside sales team and the inside sales team got a hold of it and convert -- well, essentially, they asked the customer like what are your challenges? What are the problems? We don’t have enough people. We can’t run it but we have PCI requirements. Great. Let’s talk about Complete. They left the building. They came in, they bought $2,000 and they left the building with a $40,000 annual contract for Falcon Complete. Now we’re literally giving them the best security where we’re putting $1 million breach warranty on it. And it would cost a couple of hundred thousand dollars for just one security person and for $40,000 to get the best of what’s out there and we handle it full. Yes. So just to remind everybody, when we started the company, when George started the company, the deals we went after were enterprise and we categorized enterprise as 7,500 employees plus. And so there was a head start on the enterprise as opposed to the SMB. And then recently, we talked about the $1 million deals in terms of how much of ARR are out there for that and it's roughly $1 billion. So you can do some of the math to kind of figure out where we are. So it's not like one divorce the other but we're really happy with the success of both actually. And really hard to do, right? Really hard for a company and George plated it this way that it's the same tech, same tech that we use for our enterprise and for our SMB. Really, really hard to do. For sure. George, sorry to ask this question. I know it's a fun and interesting topic but it's a question that I got a little bit after last quarter and that was around competition with Microsoft, right? I think there was a fear that maybe Microsoft was having a greater impact on the corporate endpoint security market. The question is what do you see? Is that true? I mean -- and I think even more important, why do you think CrowdStrike has a sustainable competitive advantage versus a Defender for business? Well, I mean, certainly, you have to respect Microsoft. There are big competitors out there and they got a lot of reach, right? So I mean, I've got to say that. But in terms of the technologies, like you have to start with the technology piece. Microsoft Defender is a legacy-based, signature-based AV product. If we thought that went so well with Symantec and McAfee, they wouldn't be called Broadcom and Trellis, like? So we have to start there. Customers are looking for technologies that work and stop breaches. And in fact, we have a lot of customers that come to us that have been ransomed using Microsoft technologies and they're buying a next-gen product like CrowdStrike. So from that standpoint and we called it out in the conference call on the SMB side, our win rates are actually up and our enterprise win rates are consistent. And we actually -- we were just -- we had a bunch of meetings here today. We were talking to another group and they were asking about it and said, there's a bunch of Microsoft E5 customers that use CrowdStrike. Why is that? Because it works and they're concerned about security, right? So they have an E5 license and they're still using CrowdStrike. So again, we’re the -- by market share in modern endpoint at 12.7%, we’re the number one leader but it’s still 12%, right? There’s still a lot more to go. And I think that is super important when you look at the efficacy, the cost advantage to using CrowdStrike and the fact that in a heterogeneous environment, it’s not even close. Yes, absolutely. It's funny. I mean, one of your other next-gen competitors mentioned something about the cost of going with a Defender for business actually being a lot more than the true next-gen solution. It’s a lot more people having 5, 6, 7 consoles and a lot more people actually manage it. And there’s a little bit of the just like on Christmas. You get the toy, batteries not included. Like where are the batteries, right? Servers are not included and it’s an extra expense for the sentinel. And by the time you’re done with it all, it’s like, well, we didn’t save any money, right? Yes. I think it was really important. That's interesting to hear. Burt, maybe shifting back to some of the financials. Again, like a lot of the other companies in security, we adjusted some of the nearer-term guide on revenue and ARR. I think the number that surprised a lot of us was the Q4 net new ARR potentially being down over Q3. I mean, just with -- just the enterprise customers at CrowdStrike service, I mean, that I don’t think we’ve really seen it be down sequentially over Q3. So maybe the question for you, Burt, is can we just talk about some of the puts and takes there, whether it’s pipeline, close rates, discount, etcetera. Open ended, how do you think about that different seasonality? Yes. So a couple of things. So one is with the uncertainty in the market and the macro headwinds that we've seen, we really didn't assume the typical budget flush that we see in Q4. So that was number one. Number two is with -- we saw, as I mentioned earlier, at the end of Q3, we saw this pronounced headwind. And what we said was we're going to carry that pronounced headwind into Q4, right? And I think those two things were the reasons that we gave indication in terms of net new which is something we’ve never really done other than Q4 or Q1. We thought the additional transparency into how we think about net new is, I think, important for everybody. And that’s not -- I think that’s consistent with how we’re trying to be giving out different stats over the years to help everybody kind of understand our business better. I think what's important to realize is that we're an OpEx budget, not a CapEx, right? So the OpEx moves around a bit more. And as companies are looking -- I mean, every company is saying, okay, well, what do we need to do? We got to be profitable cash flow, etcetera. They look at their own business and they're figuring out where they can spend those OpEx dollars. So I think that's important. And then as Burt said, going into next year, I think we wanted to be prudent and just carry those headwinds forward. But what's important to realize though is and I look at it and just try to simplify it, customers like the product, they buy more of it, net retention, gross retention, they keep the product. And in a space like we're -- I mean, in the current environment we're in today, consolidate A, more agents and consolidate spend. And the one thing they really don’t have is headcount. So a product like Falcon Complete is a game changer for them. And we have a video that’s coming out, it’s not out yet but a customer, a real customer, they have 5 security people. They basically said, without Complete, they would need 40. Wow. Well, I mean, a real ROI, right, in this type of environment, particularly. And George, I think that segues into an interesting question maybe back to you, Burt. First of all, thank you for the transparency for next year. I thought that was really helpful just kind of thinking through net new ARR conceptually. One of the questions that I got afterwards, right, just kind of thinking about the shape of that net new ARR next year. I think we’re assuming a little bit of improvement in the back half. I was wondering if you talk to that. I know in the first half, I think we’re thinking about a similar type of decline that we’re thinking about in Q4. You correct me there if I’m wrong. But obviously, there’s a lot of uncertainty here in the -- for next year. But talk to us a little bit about that shape in the back half, why you feel comfortable with that? Yes. So first, let's start with -- in Q2, we mentioned on our earnings call that we saw additional scrutiny right on deals. Then we just talked about Q3 in terms of where we saw more pronounced headwinds, both in the non-enterprise and enterprise. And then I think when we think about Q4, we just talked about the fact that we are not anticipating a budget flush. And so you're looking already at a lower Q4 and year than originally thought about. And then that was the baseline. And then we said, hey, look, when you look at our first half of this year, it was robust. Q1, Q2 before the macro headwinds, it was robust. So then we gave the indication next year that, hey, the first half, we see up to 10% decline from where we were this year. And then we said -- we took it a step further and we said, okay, for the full year, we’re going to be flat or modestly up. And I think that it goes to the fact that we took the end of Q3 headwinds, the sharper headwinds that we saw, we carried them all the way though. I think that's really prudent, by the way. That makes a lot of sense. So maybe putting that -- moving beyond the quarter, George, I wanted again some of the fun stuff with you, particularly with some of the newer emerging products. But actually, even before we went there, I want to talk about kind of where we are in the shift of legacy endpoint to next-gen. Maybe the question for you, George, is because you’ve been around security for years and years, right? I mean, what metrics do you maybe look at to gauge where we are in that shift? And what are those metrics telling you? Well, I can get back to our 12% number. We're still pretty early on in the shift, right? And if you look, it's still fragmented market. Obviously, we're excited about our position in it but there's a lot more to go. And there's a lot more Symantec. There's a lot more McAfee down market. There's trend. There's Sophos. There's a cast of characters that are out there in different -- and different geographies, right? You think about Japan. It’s a trend stronghold, right, as an example. So from the overall opportunity, you’ve got massive opportunity in still displacing legacy vendors. And then I’m sure we’ll talk about the cloud piece but then you move to the cloud and there’s actually no one to this place. It’s just nobody there, right? So that’s a total greenfield opportunity. So , still in the early innings of the journey even though we’ve been at it for a while. There’s still a lot of legacy technologies out there. Yes, for sure. One thing I want to add to that as well is, in my view, this hasn't just been sort of a one-for-one replace but I would argue with the shift to next-gen endpoint, we've actually helped expand the TAM as well, right? Because it's just -- this hasn't just been AV. It's been EDR. It's been all the different modules on top of that. Well, it's really the platform piece and that's what I've said for a long time and you've known us way before the IPO. But I don't look at the company as an endpoint company. I look at it as a security platform company that delivers its security via a form factor of an endpoint and cloud. And I think that's really important because when you look at when I started the company, had one module, we got 23 today. We see how that is -- that reflects itself into the unit economics and kind of the margin profile. But it’s not a point solution. It really is how do we do more with CrowdStrike, how do we collect data onetime and then use that for various workflows and then monetize those workflows. Yes, absolutely. Burt, maybe just to dig deeper into some of the faster-growing parts of the business. I mean, I think you've recently -- very helpful, by the way, provided some data points just on both the size and the growth rates around the amount of ARR coming through the public cloud as well as emerging module ARR. So maybe just to level set for all of us because I think they are important metrics, can you just remind us what modules are included in those categories? How are they performing? Yes. So we've got four modules that are in the cutter. We start with our hygiene which will be called discover, so it's IT hygiene. That's number one. Number two is we've got a vulnerability management module which we call spotlight. Number three, we have our identity module which is identity detection and protection. And then we've got our fourth which is we call LogScale which is observability and log management. So those are the four. And then when we think about -- we gave some additional data on cloud. And when we think about cloud in terms of the data that we've given out, it's our Falcon modules that are in the public cloud environment. That's how we think about our faster-growing modules. And we had a record in identity and record in LogScale. So we're really happy with the results. Yes, absolutely. I mean, a lot of those are exciting. But I got to tell you, I think identity is a really exciting area, right? So I mean, I think a few quarters ago, George, you mentioned that you see parallels in identity to the early days of EDR, right which I think is very interesting. Maybe you could just go into why you think identity has been so successful and how big that business can be over time? Well, if you sort of rewind a little bit, it gets back to the early beginnings of CrowdStrike, right which was my thesis is you have to stop breaches, not stop malware. And every other company, all the signature-based folks, it's already focused on let's stop malware and that's not going to stop a breach, right? So you fast forward to today and when you look at the big breaches that you've read about in the news, they're all identity-based. And just about all of it is around Microsoft technologies in Active Directory, right, either on-prem or on cloud. In some cases, again, somebody may again get with a vulnerability. And then as soon as the identity is stolen, they're bouncing and moving laterally across the network which is a real problem. So in 2022, I think there's a recognition for any company, why did they want EDR? Well, they weren't stopping breaches. They were just focused on malware. Okay, they bought EDR for that. Well, in 2022, there's a huge element of non-breach-related activity that is identity-based over 80%. So if you want to stop breaches, if you bought into EDR, you're going to have to buy into identity. And that's really just the next extension of it. And the beauty of what we bought in pre-empt and now it's totally integrated into a single agent is that in order to turn it on, we'll send you a license. You know what I mean? There's nothing to do. It's already there. And that's really important because we have the high ground in many of these critical infrastructures and domain controllers. Literally just turn it on and you get immediate results. And what are we seeing? We're seeing companies that use PAM technology, I'll give you a great example. We had a huge company, big financial services that kept failing their PAM test, even though they had PAM because the identities were -- it just wasn't working for what a real breach. And they had to buy our identity product in order to pass the audit from the red teamers, right? And they knew what they were doing with identity and they had a PAM technology. So that’s the power of what we see. And there isn’t a customer that we have that should not be an identity customer. Yes, that's really interesting. We've got about 10 minutes left and shift to a couple of financial questions. But before we go there, any questions here from the audience? Burt, I -- actually, you know what? Sorry, maybe I'll start with just an ARR financial question. So I think, Burt, we said in the second quarter, emerging ARR kind of broke through that $200 million mark, right? And again, correct me there if I'm wrong, growing triple digits, right? So I mean, significantly faster than the base for several quarters now. Maybe the question is, maybe this is more of a qualitative answer than a quantitative one but how big of a contributor, right, can that emerging line be to ARR over time? And are these the type of products that are more so cross sold into your base? Or are these ones that you land with as well? We'll take the second part first. I think it could be both, right? I think we can lead with one of the emerging products or it could be an add-on into an existing base. So we're really excited about the fact that they can be standalone or not, right? And that's really important to understanding you have a platform, right? You can do either. And then with respect to where it can go, we're really excited about those products. They've done well for us. They can be a meaningful part of net new ARR. Obviously, as a percentage of the total, they got a while to catch up but those can be a meaningful part of net new. And I think that we've seen some great traction in identity. We've got great traction in LogScale. And we've got some other products that we think can really be disruptive in markets and I'll let George talk about that. Well, yes, if you look at cloud, we just won CRM CNAPP Award of the Year for our cloud technology. And what’s interesting to your point is we -- there’s a couple of huge banks that use us that were just late in cloud adoption, shall we say. And the first thing they did was they put us in their cloud before we got the internal endpoint piece. Yes. So we land it in the cloud and they’re like, okay, this actually really works well. And they let their licenses run out and then we were there. And basically, we got some really massive deals out of it. Sure. Sure. it's -- I think it's been a couple of years but I still think it's a really compelling stat. How do you think about sort of the size of that security market, George? I mean, to your point, very much a greenfield market. How do you think about sizing that opportunity for cloud? Well, I look at the cloud market itself. And if you look at some of the numbers, I mean, massive TAMs, right? And then -- and we did -- I think it was about 2 years ago, 1.5 years, we did some webinar on this. But you kind of looked at the security -- projected security spend and I think it was an IDC number. It was like 1% going to 0.9. Like 1% of your cloud on security just seems way low because on average, Gartner number is like 5.7% of an IT budget. So, we just thought that was artificially low. And how can you have a security spend actually go down? Like the numbers went down. It didn't make any sense. So when we look at it, we think it's like a 10x opportunity. And even just to 5.7%, it's a massive, massive opportunity and it's not just in one area. You have cloud workload protection, pretty easy to understand. You have things like CSPM which is kind of compliance and reporting using the APIs of a cloud infrastructure provider. And then, you have all of the kind of shift left technologies, CI/CD pipeline, hygiene. How do you make sure that you're not putting tainted containers and vulnerabilities into your pipeline and you have everything in between, right? And we think it’s a massive opportunity because there’s no one there and it’s still pretty fragmented. Whoever is there, it’s still fragmented because it’s in early innings. Yes, yes, absolutely. Burt, one of the things we said at the outset was just the growth not being at all costs, right? And I just want to touch on that a little bit. I think in terms of margins, a lot of your security peers have been talking about slowing their pace of investments. You touched on that a little bit last quarter. But really, maybe the question is, how is CrowdStrike adopting or -- yes, adopting to the changing environment, while still balancing sort of the need to invest for the future? And maybe as part of that, just remind us what you said about the target operating model. Yes. So first and foremost, I just want to reiterate, we were never that company that bought growth at all costs. We'll start there. Then as we think about the evolving macro, we said, "Hey, we had tremendous success in hiring talent this year, 40% from the end of last year through the first 3 quarters." And we said, "Hey, we have a great opportunity to take that talent and really turn it into a high-performing talent across the board." And we said, "Hey, what we're going to do is we're going to slow down hiring and we're going to take what we have and make it better, more productive, enablement." And I think that, that goes a long way. It's not that we're not going to hire. We're going to hire in very specific areas. We never want to sacrifice on our capacity planning. We want to make sure that, that's still going to be what we've seen in the past and what it's going to take to be successful in the future. And then we also talk about making sure that we're not going to short-change ourselves on R&D. I think that curve still needs to continue. So for us, as we think about all of our spend which has been a great opportunity for George and myself to kind of drive that efficiency throughout the entire company, we have an opportunity to continue to show that leverage. And so an uptick, modest uptick next year in terms of our NGOI. And then in terms of the target models, from a non-GAAP perspective, we start with subscription gross margin. We took that up over the years. It's now 77% to 82% plus. In the near term, it's going to fluctuate where it's been. But I think the investments that we're making, we have line of sight to getting to that 82% -- 80% plus. It's not going to be immediate. A lot of the things and investments that we're making today, we need to continue to deploy that, those dollars to get there but we have a line of sight to get there. In terms of S&M, we look at 30%, 35%; R&D, 15% to 20%; G&A, 7% to 9%; operating margins, 20% to 22%. We're committed to getting there by FY '25. And then cash flow, we talked about free cash path to 30% for next year. So all those things are talking about the continued leverage that we have and the model that we've built, the durable model. We've got in line of sight. We've got a really good handle in terms of our spend and a lot of that is true about tone at the top. George and I are in the -- obviously, I run the annual operating plans but George is my partner of this, right, to go through the entire organization. And I talk about it with the entire company highest and best use. I think I say that 5 times a day to my own team and we drive that through the entire company. Absolutely. I think maybe a somewhat related question here for George. But one of the questions that I got -- just thinking about the capital margins which were great to see. One of the questions that I got after the last quarter was some of the customers that we have that were signing multiyear contracts are renewing with annual contracts. And so one of the questions that I got was, is that something that’s being driven by the customer? Is that something that’s being driven by CrowdStrike? And is there anything to read into that? Is there that macro? Is that just kind of par for the course? I’d love to address that a little bit if possible. Well, I think it depends on the customer and what they want to do and how they want to manage cash flow and business. From our standpoint, if you look at our gross retention rates, I mean, they're 90-plus [ph], right? So we don't mind a yearly renewal and then it's a natural touch point for new budget, new modules, cross-sell, etcetera. So it always allows us to continue to upsell and co-term and things of that nature. And we've always had a flexible model in terms of if they want to buy 3 years, if they want to pay all 3 years upfront, if they want to pay just 1 year but a 3-year contract and having annual escalators. I mean, we -- I think to Burt's point, we try to be flexible to fit within their budgetary requirements. Some customers more cash flow sensitive. Other customers more P&L sensitive, right? At the end of the day, we're really trying to be the partner to our customers. And we're going to do whatever it takes to do that. Yes, absolutely. George -- I'm sorry, Burt, just maybe on that point. Maybe a housekeeping financial question for you but I think it's a helpful one. ARR is the metric that matters to Burt Podbere. We all know that. CRPO is something that every once in a while, we'll get a question about them. Those are metrics, CRPO and ARR, just to make sure that's said. But maybe just talk to us about some of the reasons why those growth rates might be different. Yes. So we think about CRPO as a very noisy metric. First, that ARR is the metric that we focus on and it’s an annualized number. Let’s start there. And then what do I mean by noisy? It means that CRPO could be impacted by -- with a headwind type of framework then we have seen positive trends in the business. So, I'll give some examples. So number one, when we think about -- George talked about -- or we're just talking about deal duration, right? So as we move from some of the 3-year deals that we initially struck to a renewal that's 1 year that we like that, right? There's some opportunities there. It's a natural touch point for cross-sell and upsell but it has a -- it will impact CRPO in a negative way. Another one could be our co-term, right? When we co-term, it could be less than a year. So we like -- customers like co-term and it's not bad for our business. It just would have an impact on CRPO. And then finally, we do have billing schedules that are monthly or even on a consumption base. It could be whether it's our cloud offerings or MSSP. And those durations are much shorter but that's okay. That's how an MSSP runs their business on a monthly basis. That could impact our CRPO. So we can have some benefits to the company but that have headwinds on our CRPO. So that’s why, again, we focus on that ARR. Yes, absolutely. Maybe just in the last minute or so that we've got together, I mean, George, it was interesting. I mean, the lightweight agent and the power of the cloud, obviously, has been super disruptive, right, in the security market. There’s some interesting workflows, it feels like that you can kind of put around that. I was wondering if you had any thoughts on what sort of the future of that might look like. Well, as we continue to gain share and ground mind share and acceptance in many large companies and small customers have come back to us and said, "Hey, we want to do more in other areas. You have this really valuable beachfront real estate called the agent and it works. And people actually like it and the cloud architecture is super smooth. So can you give us more functionality around IT like asset information, the health and hygiene of systems, performance like at the operating system level?" So there's -- we're already there. We already have that data. So things like Discover 2.0 with our asset graph and others are providing more value above and beyond just the initial security use case. And we think that's good because we're -- the deals we're doing, we're at the CIO level. The CIO is really economic buyer and your sort of budget holder to CISO. So we're at both. But if you can talk to the CIO and say, "Hey, we can add other value in these areas." Like just telling you what assets you have or providing automation. I can tell you during COVID, we were doing patch management. We did passwords resets. We did fixing people’s remote like code that they would blow things up. They would use our technology to do all of that. And that was the IT team because they couldn’t touch all these assets all over the globe. Absolutely. Well, lots of fun things that we'd be asking George and Burt here but I think that's about all the time we've got left. George, Burt, thanks so much for coming. Really enjoyed this.
EarningCall_1472
Good morning. My name is Joe, and I will be your conference operator today. At this time, I would like to welcome everyone to the Lindsay Corporation Fiscal Year 2023 First Quarter Earnings Call. All participants will be in a listen-only mode today. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] During this call, management may make forward-looking statements that are subject to risks and uncertainties, which reflect management’s current beliefs, estimates of future economic circumstances, industry conditions and company performance and financial results. Forward-looking statements include the information concerning possible or assumed future results of operations of the company and those statements preceded by, followed by or including the words expectation, outlook, could, may, should or similar expressions. For these statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Please do note that today the event is being recorded. Thank you, and good morning, everyone. Welcome to our fiscal 2023 first quarter earnings call. With me today is Brian Ketcham, our Chief Financial Officer. We were pleased to start our fiscal year strong, delivering revenue growth and earnings that more than doubled compared to last year’s first quarter. I’d like to thank our employees, dealers and suppliers around the world for their contributions. The relentless focus on our customers and execution of our business strategies continues to generate positive results for our shareholders and supports our mission of conserving natural resources, expanding the world’s potential and improving quality of life. I continue to be very proud and appreciative of the job they are doing. Looking at the macro environment, we continue to see supply chain constraints impacting certain areas of our business. Our teams have done a great job mitigating the impact of these challenges and we expect to see continuous improvement in the situation as the year progresses. Overall inflationary pressure on raw materials and other input costs have moderated. Price realization remains strong and even in a competitive market we remain disciplined in our approach to passing cost increases through to the market. In the area of technology and innovation, we were pleased to recently announce our strategic partnership with Ceres Imaging. This addition to FieldNET expands our Smart Pivot platform and provides our customers additional choices and sources of high resolution imagery and analytics to help them make the best agronomic decisions for their crops. Allowing flexibility in customer choice is a fundamental part of our imagery strategy and we anticipate additional strategic partnerships in the future. Turning to irrigation market conditions, we continue to see strong market fundamentals in the North American market, including high commodity prices leading to record net cash farm income in 2022. Drought conditions have eased somewhat in the far west, but we are seeing conditions worsen year-over-year in the core Midwest markets, including Nebraska and Kansas. This highlights the importance of irrigated agricultural and should be supportive of a strong market. Customer sentiment is cautious at this stage due mainly to future concerns about profitability of the 2023 crop and rising interest rates. This may temper market upside, but we don’t expect this to create a significant headwind at this time. In the international regions, we see the same strong market fundamentals connected to global commodity prices and farm income having a positive impact in the developed markets particularly in Brazil. The presidential transition in Brazil has resulted in some market latency that may delay second quarter deliveries, but we don’t expect it to impact our full year results. Project activity and visibility across Central Asia and the Middle East continues to be strong, timing of execution is difficult to predict, but we are pleased with what we see in the market and our ability to leverage our global footprint to compete for and win these projects. Moving to infrastructure, we expect to see the positive impact of the Infrastructure Investment and Jobs Act in the Road Safety business. November year-to-date state and local government contract awards for highway and payment projects are up 24% compared to a year ago, supporting an increase in construction activity in the second half of our fiscal year. The full impact of this increase is being somewhat offset by inflation in construction costs. We continue to actively manage the Road Zipper sales funnel and completed shipment of our large project in Massachusetts in the first quarter. Our global teams continue to identify applications for the Road Zipper in both permanent installations and temporary lease applications to help mitigate traffic congestion and provide positive protection during roadway construction. Thank you, Randy, and good morning, everyone. Total revenues for the first quarter of fiscal 2023 increased 6% to $176.2 million, compared to $166.2 million in the same quarter last year. Net earnings for the quarter were $18.2 million or $1.65 per diluted share, compared to net earnings of $7.9 million or $0.72 per diluted share in the prior year. Irrigation segment revenues for the first quarter increased 4% to $152.1 million, compared to $145.9 million in the same quarter last year. North America irrigation revenues of $83.9 million increased 6% compared to last year’s first quarter. The increase in North America irrigation revenues resulted primarily from higher average selling prices as unit sales volume was comparable to the prior year. In the international irrigation markets, revenues of $68.1 million increased 2% compared to last year’s first quarter, including unfavorable effects of foreign currency translation differences of approximately $1.6 million. Higher sales in Brazil and other markets more than offset the impact of lower sales in Ukraine and Russia, as well as Egypt project sales of $9 million in the prior year that did not repeat. Total irrigation segment operating income for the first quarter was $28.6 million, an increase of 66% compared to the prior year first quarter and operating margin was 18.8% of sales, compared to 11.8% of sales in the prior year first quarter. The increase in operating income and operating margin resulted primarily from improved price realization, less inflationary impact on input costs and a more favorable margin mix of international irrigation revenues compared to the prior year first quarter. The prior year first quarter included LIFO expense of $5 million, while the current year LIFO impact was minimal. Infrastructure segment revenues for the first quarter increased 19% and to $24.1 million, compared to $20.2 million in the same quarter last year. The increase resulted from higher Road Zipper System project sales, which were partially offset by lower Road Zipper lease revenue and lower sales of Road Safety products compared to the prior year. During the quarter, we delivered the remaining $8 million of the $24 million barrier replacement project in Massachusetts that began in our fiscal fourth quarter last year. Infrastructure segment operating income for the first quarter increased 22% to $3.4 million, compared to $2.8 million in the same quarter last year. Infrastructure operating margin for the quarter was 14% of sales, compared to 13.7% of sales in the prior year. Improved current year results resulted primarily from higher revenues and less inflationary impact on input costs compared to the prior year first quarter. This increase was partially offset by a less favorable margin mix of revenues compared to the prior year first quarter, because of lower Road Zipper lease revenue. Turning to the balance sheet and liquidity. Our balance sheet remains solid and our total availability -- total available liquidity at the end of the quarter was $160.6 million, with $110.6 million in cash, cash equivalents and marketable securities, and $50 million available under our revolving credit facility. Through an ongoing focus on working capital management, we expect to improve our free cash flow generation in fiscal 2023 and further enhance our position to invest in growth opportunities that create value for our shareholders. I was just wondering if you could start off with any updates on larger projects internationally in irrigation and then I have one more follow-up. Sure. I will cover that one, Tyler. And as we said in the script, the timing of confirmation, the timing of execution is always difficult to predict. So really we focus on the number of opportunities that we see and right now there is a robust funnel and it’s linked to food security, population growth. We have talked to different times. The pandemic really accelerated a lot of discussions in different parts of the world on improving food security for a lot of governments and countries around the world. So we are pleased with what we see in the funnel, but it is difficult again to predict when we are going to see those confirmed and start delivering, but the funnel is strong. Right. Thank you for confirming that. And then in infrastructure, with the number of small- to mid-sized projects for fiscal 2023, how would that stack up against that one large project in Massachusetts for fiscal 2022? Thank you. Yeah. Tyler, this is Brian. I would say, what we see is an increase in the leasing part of our business in probably the second half of the year as the construction season gets underway and then as we said before, some smaller and medium-sized projects on the Road Zipper projects side of the business. And so in total, Road Safety products, we expect some growth, so year-over-year, we expect to be able to offset that Massachusetts project with growth from some of the other areas. Good morning and congrats on super results there to everyone on the team. So, it looks like what we saw here is, pricing really holding up very well as some of the inflation moderate. So I guess my question is that jump in the gross margin, how should we be thinking about that going forward, obviously, you never want to be on a call like this telegraphing anything -- any kind of negative price. But how should we think about price cost and sustainability as inflation moderates and we are up at this kind of a margin level? Yeah. I think, Ryan, this is Brian. Where we finished the first quarter, obviously, year-over-year, big increase, I think, you look at a good chunk of that attributed to the LIFO -- negative LIFO impact we had last year and not as much this year. But still you factor that out, you factor the dilutive nature of the Egypt project last year and we still had very strong incremental margin improvement. And I think what we have been saying since third quarter last year as we have gotten the full price realization that we have expected, there’s still some noise in some of the inflation. But I would say both in North America and in Brazil, we have seen some margin expansion as a result as we have come through this -- gotten through the inflationary impact, looking at a strong demand environment. So we have been able to expand margins and we continue to look at other opportunities through productivity improvement to continue to grow margins. But we are pretty pleased with the progress we have made to-date. Okay. And then my other one has to do with this issue of, obviously, 2022, talking full year -- fiscal year rather, you had a pretty nice impact of storm damage and replacement demand. Wonder if you can kind of frame that issue for us as we look ahead to 2023, both in terms of to what extent that was a driver and any way that you might be able to quantify the impact there in 2022? And then also, there’s been some talk about insurance carriers, at least some insurance carriers dropping coverage of pivots, because in part of the claim frequency with all that storm damage. So curious if you have any thoughts on how that could impact customer buying decisions going forward? Yeah. We can tackle both of those, Ryan. Looking at storm volume impact last year, I will maybe let Brian quantify that when I am through, but it’s certainly -- we will see that difficult comp in our fourth quarter -- our fiscal fourth quarter. You always plan for some storm damage in your volume forecasting and supply chain and labor planning, but last year was really an extraordinary but particularly in the fourth quarter for us. So I will let Brian quantify that. Relative to insurance, we have seen the same types of discussions and same chatter and we have been personally in contact with a lot of the insurers, reinsurers across the industry. And there’s an ebb and a flow here, I think, just like you see in the insurance market in residential homes when there’s disasters in certain parts of the country. Our view now is there’s always going to be a market. There’s always going to be somebody willing to provide coverage where it’s necessary. And even if the economics changed slightly on insurance premiums, when you look at that as part of the total cost of ownership compared to the benefits of irrigated agriculture production, we might see some hesitation, but we don’t view it as a significant headwind. It’s still going to be -- irrigation is still going to be a requirement in a lot of parts of the country and we don’t see any incremental insurance costs driving a lot of negative sentiment right now. And Brian, maybe quantification on storm? Yeah. Yeah. Ryan, I think, last year, in our fourth quarter, we had -- we kind of quantified that exceptional incremental storm damage in the neighborhood of around $15 million in revenue and so we would expect this year to kind of fall back into the more traditional storm season. But who knows what the kind of weather changes that we have been seeing, but that’s kind of how we are looking at things today. With the new partnership with Ceres Imaging, curious that option you are able to offer to customers, well, I assume that will primarily be within the North America market, at least initially? And kind of what, I guess, how do you think about the opportunity longer term to -- do they have the capabilities to go into some of the other developed irrigation markets internationally, Brazil, Western Europe and how much demand is there relative to the North American opportunity for a solution like that? Yeah. Brett, we would say that the initial opportunities are going to be largely focused on North America and when you look at technology adoption in general for irrigated acreage telemetry coverage, it’s certainly the penetration rates are higher in North America. So we do see that being a short-term opportunity. The good news on technology like this is it is incredibly scalable and I think the ability for us to leverage our channel, leverage our current installed base does create some significant opportunities. And imagery is really in the early innings in our view, and there are a lot of regional strengths even if you look at just the North American market that some companies are stronger in some parts of the country relative to others. So that’s really a key part of our strategy to offer choice for our customers and we are very excited about what Ceres is going to do for our customers and we do see some growth opportunities. But we will start in our view, with a strong base here in North America. Yeah. Thanks. Good morning. I was just hoping you could provide a little more color on just the backlog and you said it was kind of impacted both segments. Is there a way to think about it, North America versus South America and then just magnitude kind of comparing the segments and the backlog changes? Yeah. Brian, when you look at the year-over-year comparison, I would say, last year’s backlog, both in North America and in Brazil primarily were driven by still having some pretty significant price increases, which generally pulls volume forward into the backlog. I would say where we are at this year with more stability and inflation and in our prices, its reverted more to the traditional kind of selling season and the timing of the backlog. So that’s the biggest thing year-over-year, which is affecting both North America and international backlog there. And on the infrastructure side, I think, as we end our first quarter, we are into the winter, the construction season is really winding down. So that backlog is typically pretty low at the end of November. So nothing significant from our view and what that means for future results, which result, we have always said the backlog isn’t necessarily the strongest indicator of what the next couple of quarters are going to look like. Hey. Good morning, everyone. In the irrigation, you might have given a bit, could you -- what was the volume growth and the pricing growth during the quarter? Yeah. So we said the volume was comparable to last year, so pretty much flat. I think that the pricing is probably in that 7% to 8% range and then there’s some other changes that brought the overall down to 6%. Got it. And then the -- in infrastructure, the Road Zipper -- the new Road Zipper machine that you introduced this week. I was just looking at the -- I guess, the news there and the you are going to have two machines now that are available, I forgot the name like Gemini and Titan. I didn’t really understand what the one was smaller, one was bigger, but I didn’t really understand the difference, I guess, maybe applications or customers or I couldn’t tell if one was for leasing or buying. Could you just go into that a little bit more? Yeah. Again we have always had a few different models of Road Zipper depending on the application and so when it’s a lease situation, which is going to be part of a construction project, it’s, let’s say, a little, doesn’t have quite the all the options and things like that, that a permanent installation would have. So we have -- really from a branding standpoint, have come out with the two brands as we have went through the refurbishment and redesign of the Road Zipper machine. But we have always had multiple types. One, specifically for Japan that we have produced. Hawaii was another classification where it could move -- the barrier two lanes. So that part of it’s really nothing new. The big thing was just the redesign and some of the additional options that are now part of the machine. The newer machine that’s not like, it doesn’t expand the market, you don’t have like a new customer base. It wasn’t anything like that. It was just sort of iteration of the old one? Yeah. I would say, primarily. I mean, I think, it’s something that we think from a marketing perspective might drive some additional interest, but nothing game changing, I don’t think. [Operator Instructions] And with no further questions, we will conclude our question-and-answer session. I would like to turn the conference back over to Mr. Randy Wood for any closing remarks. Thank you all for your interest and participation today. We are very pleased with our first quarter results and look forward to carrying that momentum through 2023. The Infrastructure segment continues to be supported by incremental funding provided by the Infrastructure Investments and Jobs Act. The irrigation segment continues to see strong near-term fundamentals due to elevated farm income and longer term secular drivers connected to food security and population growth. The positive ROI provided by an investment in irrigated agriculture will continue to support strong markets around the world. Both segments benefit from ongoing investments in innovative technologies that improve customer profitability while conserving resources and making our roadways safer. This concludes our first quarter earnings call. We look forward to updating you on our continued progress following the close of our fiscal 2023 second quarter. Thanks for joining us.
EarningCall_1473
I would now like to turn the meeting over to Ms. Andrean Gagne, Senior Director of Communication and Public Affairs. Please go ahead. Thank you, Frank. Hello everyone and welcome to the Transat conference call for the presentation of the financial results of the fourth quarter ended October 31, 2022. I'm here this morning with Annick Guérard, President and CEO, and Patrick Bui, Chief Financial Officer. Annick will provide the comments and observations on the current situation and on the operational and commercial plans for the future. Patrick will after reviews the financial results in more details, we will then answer questions from financial analysis. Questions from journalists will be a handled offline. The conference call will be held in English, but questions may be asked in French or English. As usual, our investors ' presentation has been updated and is posted on our website in the Investors section. Patrick may refer to it as he presents the results. Today's call contains forward-looking statements. There are risks that actual results will differ materially from those contemplated by these forward-looking statements. For additional information on such risks, we invite you to consult our filings with the Canadian Securities Commission and on SEDAR and are incorporated through this statement. Forward-looking statements represent Transat's expectations as at December 15, 2022. And accordingly, are subjected to change after such date. However, we disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise, other than as required by law. Finally, we may refer to IFRS and non-IFRS financial measures. In addition to IFRS financial measures, we are using non-IFRS measures to assess the Company's operational performance. It is likely that the non-IFRS financial measures used by the corporation will not be comparable to a similar measure reported by other issuers, all those used by financial analysts, as their measures may have different definitions. The measures used by the corporation are intended to provide additional information and should not be considered in isolation or as a substitute to IFRS financial performance measures. Additional information on non-IFRS financial measures such as their definition and their reconciliation with the more comparable IFRS measures are available in our Annual Reports and our investor presentation. Good morning, everyone. My remarks today are about the fourth quarter of 2022 the year overall and trends to watch in 2023. The fourth quarter was the strongest of the fiscal year. We are clearly on the road to recovery. Our results are improving and our confidence is growing. With each quarter we have seen more robust sales, increase activity and improvement in our financial situation, so this momentum is continuing. These last few months have shown something powerful. People have a strong desire to travel. Spending on travel is a priority to consumers. Their need to go abroad is a main factor driving Transat's recovery. Through careful planning, disciplined execution and targeted investment, we are capitalizing on this favorable consumer demand. For the quarter that ended on October 31, 2022, revenues reached $573.1 million compared to $62.8 million for the same quarter in 2021. Our operational performance improved over the month and low factors saw a sharp rise and return to more normal levels. For summer 2022, capacity was 86% up 2019 levels, while the average loss factor was at 82%. Turning our attention to the 2023 winter season, the trend is clear and booking patterns are encouraging. Over the last month, we have seen a strong pace in bookings comparable to the one in 2019 and even higher during certain weeks. The average load factor for the season had reached 56% this week, which is highly comparable to 2019 levels. And as indicated by our yield, consumers are ready to be more to travel, approximately 15% more than they did in winter 2019. All this activity has allowed Transat to close the year with good positive momentum. Our adjusted operating loss for the fourth quarter has narrowed significantly to $11.5 million compared to $58.4 million in 2021. The situation is expected to trend positively in 2023, even though some uncertainty persists. Transat financial situation although far from ideal as stabilized, we continue to be disciplined in the management of our costs and focused on the optimization of our working capital. During the last quarter, we continued implementing our strategic plan, our fleet renewal efforts speak to our confidence moving forward. At the end of November, we placed an order for two more A321LRs. This is in addition to the order for four A321XLRs announced at the end of the previous quarter. Today, we have 23 of these next generation aircraft in our fleet or on order. As we have explained on several occasions, this modernized fleet continues to provide us with increased operational efficiency, especially in the context of higher fuel cost. As we continue to renew our fleet, we are also improving our network. In October, we introduced a new code-sharing agreement with Porter Airlines. This agreement follows others signed in recent months with WestJet and 10 other partner accessible through connectair by Air Transat, our virtual entry lining offer. Code sharing increases the number -- the total number of destination available via Air Transat to more than 300. With these partnership and additional ones to come, we target three objectives; increase the number of destinations proposed by Transat; increase the number of flights proposed for a same destination; benefit from the partners sales force. Ultimately, this will have a positive effect on our main objectives to grow our revenues and increase our capacity including during low season in order to reduce seasonality. Now, looking ahead, the trend heading into 2023 is positive. People want to travel, creating strong demand, which in turn is driving prices higher, ultimately contributing to increase revenues. That cascade effect would help us to deal with rising costs and to cope with the economic slowdown. While the months to come, we will have their share of economic uncertainties, current trends suggest that the demand for travel should remain resilient. For 2023, our capacity will be equivalent to 90% of 2019 level. That activity level is consistent with the pace of recovery Iota foresee, however in Eastern Canada markets where we are concentrating our activities, we will actually deploy a capacity close to 7% more than in 2019. Our network redesign will allow us to increase our fleet utilization by 16% compared to 2019. With what we see today in terms of booking and pricing trends, we are targeting an adjusted operating income margin between 4% to 6% for 2023. Patrick will explain these expectations shortly. To sum up, demand during the fourth quarter was stronger than Q3 and continues to build. We are returning to pre-pandemic activity level. Since the start of October, our weekly sales have regularly outperformed 2019 levels, selling prices are higher and so are our revenues. Our financial situation continues to improve and we are taking strategic actions to return to sustainable profitability rapidly. During fiscal 2022, we made progress on all major pillars of our strategic plan, fleet renewal, network optimization, and the introduction of airline partnerships where our top priorities. We attain a significant milestone with the launch of our first code share agreement. Everything is now in place with our systems to increase the number of partnerships and support our strategy. From a financial perspective, we renegotiated our loan agreements with the government and preserved our cash flow accelerated the recovery and increased activity have allowed us to intensify our recruiting effort. Throughout the year, we hired or rehired 1,800 employees. Moreover, our labor relations continue to be excellent. Last month, we reached a new five year collective agreement with our maintenance team. And in the second quarter, we ratified a new contract with our pilots. We also created a new vice presidency corporate responsibilities to strengthen our commitment to environmental, societal and government issues. The mandate of this team is to better support the priority objectives of our strategic plan in this area, which includes promoting diversity and inclusion in the workplace and decarbonizing our operation. A cross functional committee was established to develop our climate action plan, including the identification of medium term targets for carbon emission reduction and sustainable aviation fuel supply. Significant investments were made in our brand visibility this fall. We launched our first major branded advertising campaign in three years. This campaign has contributed to our strong booking trends this next winter, Customers are aboard and we have improved their overall booking experience by increasing and maximizing our website's self-service capabilities. We are putting all the pieces in place for return to profitability and value creation. As we close another fiscal year with confidence, I wish to thank all our employees, my colleagues on the executive team and the members of the board. We are heading into 2023 with enthusiasm. Good morning everyone. The fourth quarter ended October 31, represents an important step forward in our financial performance. We are ending a challenging year by narrowing the gap in adjusted EBITDA loss and opening 2023 with encouraging signs. While an adjusted EBITDA loss of $11.5 million is an indication we are still ways from our financial potential, it does point to a positive momentum, as we have been at an adjusted EBITDA loss of $60 million in the past nine quarters on average. This positive momentum provides us with a better view of the future and confidence in setting financial targets and guidance for the full year of 2023. Our fourth quarter of 2022 open on a strong summer peak in August and continued with improved financial performance during our shoulder season in September and October. Progress was made despite sustained high fuel prices in U.S. dollar. On average during the quarter, jet fuel was at $3.72 U.S. per gallon and the U.S. dollar at $1.33. Looking forward while our plan capacity is still lower than 2019, bookings are currently tracking at the pre-pandemic pace of 2019. For the winter season from beginning of November to end of April, load factors have reached 56% consistent with the pattern observed in 2019. On the pricing front expressing airline unit revenues or yield, prices are 15% higher than 2019 on average, led by strong momentum in both our and transatlantic programs. The combination of demand increasing prices will help offset the increase in operational costs due to inflationary pressures. Excluding fuel and hotel expenses, our unit costs are projected to increase globally by roughly 10% compared to 2019 or approximately 2.3% per year. Fuel prices have also been on the rise although have recently receded, and we are continuing our hedging strategy on both oil and FX for 2023 to contain any sharp increase. As always, we remain vigilant on the economic situation and potential impact on demand. At the current time, we do not see a negative impact on our booking trend. The ongoing pent up demand seems to provide for an atypical resilience, but we remain highly vigilant. We close 2022 with a strong cash position, a $100 million undrawn facility, no maturities until 2024 and improving working capital dynamics, all of which are necessary to pave the way to a full recovery. That said, we remain acutely aware of our indebtedness levels. We continue to plan for the deleveraging phase which will come from a combination of improved profitability, cash generation, improved working capital dynamics and refinancing. And now with respect to our Q4 results, revenue stood at $573 million up from $63 million in 2021, driven by the resumption of operations with capacity heading towards 2019 levels, with 91% of 2019 capacity across all markets. The return of demand combined with higher fuel prices contributed to the increase in our average selling price. Adjusted EBITDA was negative 11.5 for the quarter compared with negative $58 million in 2021, which represents a significant narrowing of the adjusted EBITDA loss despite significant headwinds. During the quarter, there was a significant increase in fuel prices, 61% surge or $73 million, and a 6% weakening in the Canadian dollar against the U.S. dollar. Adjusted net loss was $76 million compared with $118 million last year, and for our financial statements, a net loss of $126 million compared to $121 million last year, a $5 million deterioration. Now with respect to our balance sheet, as at October 31, the corporation's cash and cash equivalents amounted to $323 million with undrawn facilities of $100 million for a total unrestricted liquidity of $423 million. The cash and trust or otherwise reserves totaled $376 million while deposits for future travels stood at $603 million. We were up 7% from pre-pandemic levels as at October 31, 2019, reflecting the recovery in demand and higher average selling prices. Our net cash burn was $70 million for the quarter. The cash burn was negatively affected by the timing of the conversion of our receivables into cash. Since the end of the quarter, the corporation agreed with its credit card processor partners to a one-time lump sum release of $75 million from our accounts receivable as of October 31, 2022. Separately, last quarter, we announced the selection of Nuvei as a new credit card processor in our payment system and we are happy to report that this partnership is now operational. With respect to our indebtedness, there were no further drawings on our credit facilities during the quarter and remained at $863 million. Lease liability stood at $1,088 million, which includes 12 LRs, two of which were delivered during the previous quarter. Off-balance sheet agreements, excluding agreements with suppliers stood at $978 million. This is an end discounted figure, mainly related to the five LRs and three XLRs yet to be delivered as of October 31. For the full year of 2023, we expect capacity to represent approximately 90% of 2019 capacity. Our overall capacity deployment is consistent with demand projections provided by Iota in the regions we serve. With respect to margins, we are setting the adjusted EBITDA target at 4% to 6% for the full year, representing an important milestone in our recovery. In providing such guidance, we use a combination of assumptions including moderate growth in Canada's GDP and the risk of a short recession, exchange rate at a C$1.34 for $1 and jet fuel price per gallon of C$4.50. Should any of these assumptions vary significantly, we may adjust our guidance. Thank you. Thanks very much. Good morning. Maybe just a couple questions on the outlook and I guess maybe first just want to reconcile, I guess, sort of the capacity guidance that you have put out 90% of 2019 levels for the full year. If I look at what you have indicated for the winter, its capacity down only 3% relative to 2019. So I'm wondering, if you can maybe describe what that implies for the summer season, because it would seem that, that maybe summer capacity plans would be something less than 90% of 2019 levels? Yes. So, we are forecasting indeed minus 3% for the winter. For the summer, we are forecasting minus 14%. So in total that gives us minus 10% for now for the whole year. Okay. So if I look at what you just flew in Q4, it was, I believe at 91% of 2019 levels. So would that sort of imply that you are going to be flying, I guess less or the plan flying less in Q4 next year versus what you just did? No. We will not. We are just applying capacity differently. In addition, we have -- we are putting more capacity on Europe. We are increasing our capacity as well in shoulder season. At the same time, we want to make sure that we don't deploy too much capacity based on what we foresee for the demand. Second question just on I guess the winter. Obviously, things are looking pretty positive from a booking perspective and from a pricing perspective. If I look at, I just want to maybe understand maybe the seasonality here between Q1 and Q2 because historically with Transat, we would have seen a negative EBITDA in Q1 and then you're more positive in Q2. What is your expectation for this winter? Are we going to see like a significant difference in I guess, the margin profile Q1 versus Q2? Yes, I'll take that one. I mean, yes, as you noted Q1 is our best quarter. We are still projecting in Q1 an EBITDA loss, not a significant loss, but loss in Q1, and then you should see a pickup in terms of positive margins in Q2. Just filling in for Tim James here today. Just got a few questions actually. Firstly, could you please provide an update regarding the traffic being generated by the WestJet Atlantic code-share and then the new Porter code-share agreement as well? First of all, it's very early because we've just introduced those alliances. So, we see a great potential. But at this point, it's a little bit too early to share numbers. These are agreements that are focused on increasing the connecting traffic on European routes, which we already see, and we will be able during the upcoming year after a few quarters to be able to share those data. Okay, no worries. And then, I guess just our second question more so related to the 15% higher yield. So, how much of the 15% higher yields currently for the upcoming winter due to mix so i.e. more higher and packages? And how much of that is actually due to price increases for a given trip? Oh, yes, what's the split between the increase in pricing of packages versus flights, the 15% refers to flights, the 15%. This is Jessica filling in for Kevin here. I guess just a quick was for me. Given the -- and I appreciate the margin guidance of 4% to 6%. I guess, given the puts and takes and all the strategic, all those strategies you're pursuing? What would you say would be a normal life margin? So, yes, you're right, 4% to 6% is 2023. And then, I'll just build up to our full potential. But then if you look at our historical margin, so looking back roughly the past 10 years, you adjusted for IFRS-16 and discontinued operations. The business has delivered let's say on average 7% margins. I think 2019 was 6.6. So, we expect to be above that or around that in next year in 2024. And then, we think the full potential of this business is definitely double-digit in terms of margin. Now, what exactly will come back in due course, but our strategic plan assumes and should deliver way better margins that we were able to produce in the past. So again, think of it as double-digit margins at full potential. Maybe just on returning the pre-pandemic levels. How should we expect the cash flow move on next year? And what kind of margin would you need to produce on an operating margin level to produce positive free cash flow on the time? Thank you. Yes, so in terms of cash flow, we're consistent what we've said in the past that we would be cash flow positive by 2024. And so 2023 is still a transition year, when we provided guidance of 4% to 6% and you do an analysis you can see it's below what we've been able to produce in the past. Now obviously, if we can be cash flow positive, that is definitely our objective. One thing to bear in mind is in 2023 to keep an eye on, is working capital dynamics. We mentioned this morning that we freed $75 million post end of quarter. And so, we think during the year, a portion of cash or cash generation will come back in the form of normalized working capital. But for the full year 2023, our objective again is to be as close as breakeven as possible, but again, we maintain the line that it should be by the latest 2024 in terms of cash flow generation. Very well. Thank you everyone. Let me remind you that our first quarter results will be released on March 9, 2023. Thank you and have a nice day. That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line.
EarningCall_1474
Good. Okay, let's start. Hey, welcome to our next session. I'm really happy. I feel like now an Internet guy because like now we're talking about LinkedIn and kind of proper, a good kind of assets that are kind of dealing in the social world. And so if some of my questions feel like this is the software guy asking me silly, silly questions, so I apologize in advance. Yes, Ryan, like, since this is the first time, no, it's been a while since we're out on the conference circuit. And a lot of things have changed, you became the CEO during the pandemic, like, maybe introduce yourself a little bit first, and then kind of we go deeper into questions. Yes, thanks for - again, for having me. My name is Ryan Roslansky, CEO of LinkedIn. I've been the CEO for the last since February 2000, which was a great time to - 2020 was great time to become a CEO of any company, obviously. I've been at LinkedIn before that for about 14 total years now. Worked across the product org and literally every single part of LinkedIn’s business, we run a social network in the core. And we have five distinct business lines that cross around that social network. And I've had the pleasure of working on or starting every single one of them. So it's an honor to be here today with you. Oh, right. Okay, perfect. So if you think about the last few years were like, very fascinating and kind of positive and negative way in terms of how the world has changed, and how work has changed as well. And kind of from a LinkedIn perspective, like what stood out for you in terms of the changes that are kind of happening, like happened? And well, let's start at that as a very open question. Yes, I mean, one of the really unique things about LinkedIn is at the core, I mean, we're kind of a massive social graph. And that graph has a variety of components nearly 900 million professionals, roughly 50 million companies that have an active presence on the platform at any given time, those companies are posting between 14 million to 16 million job openings. There's north of 100,000 schools that have an active presence on LinkedIn. We're the only western network that operates in China. So we have a real global view on what's happening. And the connections between all those entities we just talked about, the graph updates, roughly 5 million times per minute in terms of the connections between those entities and what's going on, so it's a really unique view, real-time view, and what's happening across the global labor market, can tell you which industry is going to be hot, three months from now. What companies are about to go out of business, where skill gaps truly exist across the world. So it's just a really unique view, kind of in the real-time labor market. We actually work now with a lot of the governments across the world to help provide them with more, what I'll call real-time and accurate data about what's happening in their labor markets. Because we just have that that view. So I mean, there's been a lot of tremendous insights over the past couple of years, one, that we paid a lot of attention to, which I think everyone felt and talked about was, there's a stat that I look at pretty frequently, which is, we call it position changes, it's basically someone changes their profile from going in a position at one company to position to another company, it's that simple. And historically, the year-over-year, like deviance in that metric is literally like negative one to like plus 1%, it stays pretty constant in terms of the percentage of narrow base, that's changing jobs. When COVID hit, that number dropped. It dropped to like negative 20%, which makes sense. People were sheltering in place to try and figure out what they want to do with their life or write up the uncertainty and then ever skyrocketed. And this is what people have called the great reshuffle or the great resignation. But my goodness, like the number of people that were changing jobs on LinkedIn back a year, a year-and-a-half ago was, it was unreal to watch. I mean, north of 100% year over two years on the movement, and it was just -- it was crazy to watch kind of the movement in general. But what was really interesting is if you break down the kind of that reshuffled data by generation baby boomers, they really weren't moving at all to be honest. Then as you kind of keep going up the kind of generational spectrum, people are moving more frequently. And then you get to like Gen X. And I mean, this is a group that's moving like north of 300%, like through the great reshuffling. In fact, it's still, right now it's all kind of elevated back down into that like negative 1% range again, it feels back to normal, but Gen Z is still moving north of 30%. And I think this is a generation, it just feels like you're supposed to move jobs frequently, or that's how the world works. And it's a, I think looking out, it's really a generation that's going to need to be heavily inspired and motivated. And companies are going to have to figure that out. So I think that's one thing we pay attention to. On the job side something fascinating right now that I look a lot at is pre-pandemic, about 1% of all jobs posted on LinkedIn were remote. As of today, that number is about 14%. So we've seen a huge jump in the number of jobs that are remote. But that's not the fascinating part. What's fascinating is north of 50% of all job applications on a daily basis on LinkedIn, go to that 14% of remote jobs. So there's huge demand still, at least on the labor side for remote work. And then actually something we were just looking at this morning walking over is what kind of tracking where people who are moving, physically moving locations for jobs. And I don't know, I mean, I don't know if you were to call it, I probably would have called it a few years ago. But right now, the three biggest markets, people are moving to physically moving to New York, San Francisco and Seattle, there's like this move back to the cities. And I mean, there's real movement right now. So I know there's a couple of things that I'm paying attention to. Yes, that's interesting. Do you think that Gen Z, or like let's call it the younger generation, do you think that's a permanent thing? Or is it like, because like the discussion, we have it as well as is like, because they were younger, there's a whole new world of feeling differently about work, et cetera? Do you think they will eventually get old and settle down like the rest of us? Or do you think it's a permanent change to what’s going on – I haven't seen anything in the data that would suggest slowing down. In fact, it's starting to - the frequency with which they're changing jobs is actually increasing and it's starting to really deviate even from millennials. So I think it's, who knows, I wish I had a crystal ball on that. But at least it's kind of the new way of work. And it's not just moving jobs, but it's kind of having the side gig, maintain actually a couple of side gigs along with your core jobs. So we'll see. It’s global, yes. It's a great question. It's a global phenomenon. I mean, it indexs higher in the US, but it's happening globally. Yes, that's amazing. Okay, yes. Okay. Germans don't stay in that job anymore, okay. What's going on? Like, another thing that's interesting is, it's kind of if you think about skills, and degrees and pedigrees where people are coming in, like, what do you see there in terms of the future of talent? Or do you see any trends playing out there? And like, and also like, how does LinkedIn learning play in there to help that bridge the gap there for some one? Yes, I mean, I think be it due to COVID, or digital transformation, or I mean, a fourth industrial revolution. Jobs are being created and displaced right now at a record rate. And historically, what we, I mean, all of us in this room, and the world has used to assess talents are things like, where did this person go to school? Or what was their previous company? Or do they know someone that I know? And I think that's fine when the market’s moving slower, but at the pace is moving now that's actually the world needs more flexible and alternative and always on mechanisms to assess talent. And my perspective is that's going to come through kind of a skills-based approach. It's those other things are actually really valuable. But it's most importantly, like, what does this person know how to do? Or what can we be trained on what to do? Kind of skills being the center currency and think about it, we're doing across LinkedIn. I mean every minute, we're just basically trying to - we're trying to match like this person over here with this job over here, like do these two things match up because ultimately, how we drive value back on LinkedIn is if someone hires someone else, and when you look at skills is kind of the centerpiece of that matching algorithm. You're able to find much better, wider talent pool, it's a much more efficient and a much more equitable talent markets. We've been pushing a lot on this and the technology's there, I think it's a mindset shift, and a lot of folks have to go through. But here's a really, here's like one of the best recent examples to showcase how this can be done better. So through the pandemic, and they then it starts on LinkedIn, you see all these food service workers, like become unemployed, which makes sense, people aren't going to restaurants, like they don't have a job. On the flip side, the highest most in demand job being posted on LinkedIn early pandemic was digital, like customer service agent, which makes sense because it means moving online, you need people to help service all this. And you look at the group of the foodservice workers, and on average, they have 70% of the skills that you need for these entry level digital customer service jobs, literally 70% like, pretty much almost there. But the folks doing the hiring aren't looking at that talent pool. The folks in that talent pool have no idea that like, there's real opportunity here. So these two things go, like in an inefficient way not being matched. And again, like we drive value by matching these two things together. So I mean, we see this happening all over the world right now. But I think that the more that we can start to focus on skills to be the currency, it's going to help to make that a more efficient labor market, which is great for our business, but also great for the world as well. Yes, okay, perfect. And then the - for a lot of us, like more on the software world, we kind of we know LinkedIn as a great platform to kind of connect people like people each other. Like, can you talk a little bit about like, you talked about your five pillars of work there. Like, how do we evolve from that? Like, what are you using that kind of base information world to work with people and give them special offerings? Yes, I mean, we're called the job site, we're called the social network. Fundamentally, the vision for what I'm trying to create is that we're a platform that exists to create economic opportunity, and right now, really focused on three marketplaces. So first and foremost, the exchange of knowledge between professionals, either in paid form through LinkedIn learning, or just through kind of our core sharing and feed products. We, about a year ago, released a newsletter product that allows professionals or publishers or companies to create a newsletter, you've heard a lot of other companies that do this as well. A year later, we have 150 million subscribers to these newsletters, it's a really valuable way to disseminate and share professional knowledge and information. And we're just keeping kind of building features like this, because at the core, we believe that we can help it's good for our business, and it's valuable for the world, if we can help kind of the free-flowing exchange of knowledge between professionals, that's kind of the core thing that sits at the center of LinkedIn. And there's two more marketplaces that run through and on top of that versus a talent marketplace just constantly connecting people with jobs, either through passive recruiting, or through active job seeking, roughly 10 people per minute will start a job, literally start a job that was found through LinkedIn. And we're just moving much more aggressively internationally into kind of the first line of frontline segments as well. So we're just trying to expand that marketplace to again, help connect anyone in the world looking for opportunity we then we're looking to hire them, be it full time, freelance gig, et cetera. And then on top of that, we call, we have what we call the products and services marketplace, where we're trying to ultimately connect potential buyers or active buyers with sellers or marketers, obviously, in a b2b context. And probably the largest TAM, actually, for us is in that marketplace. We do it through a product called Sales Navigator than our obviously our advertising products, which have really kind of shown a lot of strength over the last couple of years. So that's the framing which we look at it. But ultimately, what we're trying to do across the board is to basically connect two people like someone sharing knowledge, someone seeking knowledge, someone looking to hire, someone looking for a job, someone looking to buy with someone looking to sell or market to and like that framing, I think, is what's been really valuable to help us grow over the last couple of years. And then because we're the financial guys here, like the - I am just trying to kind of how does that link in like, if you think about that evolution of the platform and the opportunities, that kind of platform then provides to do more stuff. Like how do you think about like, oh, I want to do more on Sales Navigator because I'm kind of making more money there or like, how do you think about growing the business and where do you think you will kind of end up? Well, I mean, the good thing about it is, it's a very diversified business. So I mean, obviously, we are inside of Microsoft and very grateful to be kind of inside of Microsoft umbrella. But if you look at the past, the - kind of the trailing four quarters, that kind of Amy Hood, the CFO of Microsoft has talked about LinkedIn. We're doing north of $14 billion in revenue growing at 28%. And it's because of this diversified set of businesses. We - all of it really kind of goes back to how do we effectively be connecting people against these value propositions that I just talked about. And LinkedIn has become much more mainstream as a knowledge marketplace, we've seen just engagement soar over the past couple of years. And that engagement with the valuable profile data that exists on LinkedIn is kind of the core thing that helps to power all of those businesses. Yes. Okay. And then I want to switch gears a little bit like if you think through the consumer-driven like, Internet giants, they have like a different world, there's, they're very more heavily dependent on advertising spending and stuff like that. What - you're more in the business world, like, what are you seeing on the net aspect? Yes, I mean, when I joined LinkedIn, 14 years ago, I had the pleasure of starting our advertising business, and at the time, we were kind of a job site. And it was like, why would anyone use LinkedIn to advertise. But what's so valuable about LinkedIn for is that we're focused on b2b advertisers, like, that's kind of our sweet spot. Literally, if you're looking to sell a high end b2b product, and you know the buying group is a CFO and someone in finance and like someone in HR, we can literally, like put ads in front of those specific people on LinkedIn, because the first party data is so strong, people keep their LinkedIn profile up to date, because their professional profile records the resume online. So our ability to target ads against that first party data on LinkedIn is really strong. I think the context is really helpful for us as well. People want to have their ads around professional content, especially in the b2b space. So I think that helps us a lot there. And in general, and the more that we get people using LinkedIn, the more we get them using our feed, and sharing knowledge just creates great inventory for us. So pretty bullish in long term in general, for our advertising business. And again, the connection to Sales Navigator, because a lot of these are just, lot of these address generating leads to go into salespeople to help them understand how to better connect and sell to those people. So there's just a really valuable b2b market there, I think, in general the drivers of an advertising business, you obviously have unique engagement on one side, and then you advertise on the other side, and we're seeing both of those still relatively strong. I mean, the engagement side is really strong. And we're seeing advertisers still coming to LinkedIn, I just think like the rest of the world, we're seeing them, their budgets pulled back a little bit, so willing to be spending less on kind of a per click or per lead basis right now. So still bullish about that business. I think we're going through a cycle right now; I think the b2b context in differentiation helps us a little bit, but we're not immune to what's happening currently. I mean, from your experience from previous cycles, or when you saw, what saw pandemic or ’08, ’09, et cetera, while ’08, ‘09 maybe too early, like the, you kind of, in a way with that and cyclical but like less in terms of magnitude cyclical compared to like the consumer price. So how would you kind of characterize it? It's interesting, because what happens on LinkedIn to your earlier point about the diverse business lines, what happens to LinkedIn, in a cycle, we see just a huge wave of engagement through job seeking, a lot of people are looking for jobs, we see a lot of engagement in our kind of our paid learning products, because people who are looking for jobs or kind of back to my skill point or trying to upskill themselves to the jobs that exist and try and pick up and learn new skills. And so again, kind of the dynamics of an ad market are engagement and then advertiser demand, and both of these things can kind of go in different ways. Right now we see the engagement side, just really kind of pick up and the advertising side is still there. It's just a little bit muted to where it was probably a year ago, which I think is probably right. Okay. Then I wanted to switch gears a little bit like you have now what 875 million members. And if you think about the growth opportunity there. I mean, it's already like a very big number. How should we think about that number going forward? And where do you see opportunities? I'm thinking maybe international more, et cetera, like, but like, I'll let you speak to it. There's 835 million members on LinkedIn, we're growing right now. There are three members that join LinkedIn every second and 35% of those members are kind of frontline right now, which is different. Two thirds of those members are outside of the US, a lot of strength right now in Asia Pacific, a ton of strength right now in India, we're nearing 100 million members, right now in India, these members are over indexing on everything that you need for our economy to move forward. So networking and job seeking and learning is something really unique and special right now, I feel like it's happening in India. In LinkedIn grows, we don't spend money to acquire users, it grows, it's a network. So people join LinkedIn, they upload their address book, and whoever's in their address book gets invited to join LinkedIn along with him. So the network kind of grows in these organic ways, along with kind of where the pockets of growth are happening right now. So my, the vision of the company is to help everyone in the world on economic opportunity. So I think that hopefully, that's where we aspire to be. But I think we're seeing accelerated member growth right now. And it's especially coming internationally, India, Southeast Asia, Brazil, and more than we have ever seen before, kind of in the frontline sectors. Yes, that was actually my next question on the frontline doesn't strike me from the outset as like LinkedIn, like, initially, at least initially think like, because it's more of like, the office workers kind of networking, et cetera. Like, how does that fit in there? But and the question is, actually, what was my, why did the frontline workers not kind of, why are they only discovering it now? I think they're discovering it now, because of what I just explained, which is, again, people discover LinkedIn, because someone in their address book or that they know, connects, or ask them to join LinkedIn. So you get these pockets, and then that growth kind of happens, right, which is one of the beautiful things about kind of these social growth products is how they grow on their own. But we've never really had on the recruiting side a lot of companies who were coming in posting kind of frontline jobs on LinkedIn. So there was no reason for people to kind of join in the first place. Now that's starting to change, companies are posting all their jobs on LinkedIn, company like Amazon will just literally post every single one of their jobs, no matter where it is in the company on LinkedIn. When that happens, it brings those people onto LinkedIn, because maybe they'll find the job through SEO, et cetera. They joined LinkedIn, they invite their people that they know in their connection to join LinkedIn, then that just kind of starts a cycle there. So that's where a lot of that growth right now is coming from, then the great thing for us is that when you start to see a lot of these folks joining LinkedIn, allows our sales team to go out to find new customers saying, hey, these folks are on LinkedIn, the folks you're trying to target and for us to kind of open up that level of business. So as we kind of balance the marketplace. Yes. Okay. Next question I wanted to ask, it's like, you mentioned earlier that Microsoft relationship and how much you enjoying it, like, what's the, how do you have to think about that what Microsoft brings to the table, like you were in LinkedIn before, you were part of Microsoft, like, talk us through, like, how they are helping or what's different. I mean I think we're nearly six years past the date of this acquisition, we were doing roughly, I think, $2 billion something dollars in revenue at the time of the acquisition, we just crossed $14 billion the businesses nearly quadrupled. The member base has doubled engagement, 2x or 3x what it was. I don't know, I think looking back, this will be thought of as one of the much more successful acquisitions in technology. A decade in I just think Satya Nadella had this super intelligent vision understanding of how, if you can let a company, think long term, if you can let a company have access to next levels of technology, you can unleash a ton of value. And that's exactly what's happened. LinkedIn is completely standalone, completely standalone inside of Microsoft still, I mean, six years in and look when you see the success that we're having it makes sense. If we need access to technology, I mean a lot of the AI stuff that you're going to see coming up my goodness if we were standalone company, we wouldn't have access to the same stuff we do through Microsoft, access to distribution partnerships, is unique access to some go to market stuff when we think it makes sense. But most importantly when you're not a standalone, smaller public company trying to make sure that every quarter you're thinking about some short-term things to eke out something that you need for to meet that quarter, and you can think longer term. It's amazing. And that's exactly what's happened with LinkedIn and Microsoft. So I love it, I get to sit in a weekly staff meeting with people like Satya Nadella and Amy Hood and Brad Smith. And then my goodness, like learn from the greatest leaders in technology. So it helps me then I can take that back and help grow LinkedIn. So I think it's a just I think Satya has written a book on how to do a successful acquisition like this. It's really exciting so. And if you look at other deals in tech, usually what you do see is like the mothership take something over doesn't really understand it. And Nadella was few now, like so for Microsoft taking over, like in more internet focused company, the founder leaves, like, within a year after the contract really goes away. But you're only now took over and you've been there for 14 years, like what, like, if they're, like, usually, then there is cost cutting coming in, it's a lay-up, but it does look like this is all very different. Like, it's -- Yes, look, every acquisition is different in terms of what you're trying to accomplish. I think the thesis the Satya probably had was like, hey, LinkedIn, if put in the proper environment can accelerate growth, and LinkedIn with access to the right technology, the access to the right distribution partnerships, can accelerate growth. But LinkedIn, it's not like something's broken. It's not like, it's not even like there's this obvious like, technology overlap. But if Microsoft owns this asset, we can absolutely accelerate the growth. And that's the thesis, the different thesis in some acquisitions, but I think it was, I mean, it's played out to be spot on. I mean, we decided 2.5 years ago, to start building a much more, we started at pandemic, obviously, people can't get together for events like this. So events are moving online. And like my goodness, like, LinkedIn has got to be the place for people and professional events. And that real time like video technology, if we were some standalone companies trying to figure that out, it would have taken us years to figure out. But when it's like, here's an API to the team's framework, we can launch like an event, real time events product in like a month. I mean, it's unbelievable. It just gives us such an advantage to be able to grow LinkedIn. So I see your point. I think every acquisition works like that. I think other acquisitions have different thesis. But this one to kind of be standalone and let LinkedIn grow is paid off really well so. Yes. Okay. And then I've only got time for one more question, Ryan, like, but I can't let you go without asking the more the question that probably everyone in the room was kind of thinking, since you have the graph, like, what are you seeing at the moment in terms of like, how our world is changing? Do you see any kind of early signs that this is kind of a little worse than what we think or like, like, what's the graph telling you at the moment? The only thing that it's telling me right now, is that there not one story happening. And I'm not smart enough, as all of you to understand, like, the nuances in that, but I mean big tech is hiring less. Healthcare, I mean, they can't hire enough. I mean, they'll do whatever it costs, which is why some of the skill stuff makes sense, because you can pull people out of other industries that have the right skills into new industries. Even inside of certain companies, you'll see like half the company hiring way less, half the company hiring way more. So I just think that it's not one story right now. It's literally 1000s of stories that are different based on geography, industry and company size. And that's at least unique to mean, in the 14 years I've been looking at this data so. Sorry, it doesn't give you some crazy insight, but I'm trying to figure out as well.
EarningCall_1475
Ladies and gentlemen, thank you for all joining. I would like to welcome you to the Vince Q3 2022 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. [Operator Instructions] Thank you. I will now turn the conference over to your host Amy Levy. Please go ahead, when you are ready, Amy. Thank you and good morning, everyone. Welcome to Vince Holding Corp’s third quarter fiscal 2022 results conference call. Hosting the call today is Jack Schwefel, Chief Executive Officer, and Dave Stefko, Chief Financial Officer. Before we begin, let me remind you that certain statements made on this call may constitute forward-looking statements, which are subject to risks and uncertainties that could cause actual results to differ from those that the company expect. Those risks and uncertainties are described in today's press release and in the company's SEC filings, which are available on the company's website. Investors should not assume that statements made during the call will remain operative at a later time and the company undertakes no obligation to update any information discussed on the call. Following today's remarks, there will be no question-and-answer session. Thank you, Amy, and thank you everyone for joining us this morning. I will begin with an overview of our third quarter performance focusing on our Vince business as we have continued to execute the wind down of our Rebecca Taylor business that we announced in our Q2 call. Similar to others, the third quarter was challenged by macro-related headwinds as our consumer continued to contend, resulting in inflationary pressures and higher interest rates. And the retail sector increased its promotional activity as many, including ourselves, took aggressive actions to reduce inventory balances. With our strategic decision to exit the Rebecca Taylor business, we have realigned our research to focus on the current scale of our business, and are continuing to evaluate our processes and cost to drive further efficiencies and enhance disciplines across our organization. We believe through the actions we are taking today, we will be better positioned for long-term profitable growth. Now turning to our Q3 results more specifically, our top line performance headwinds was driven by our wholesale channel where we saw nice reception across our men's and women's assortment, particularly as we transition into the cooler fall season. The performance offsets a slight decline in our direct-to-consumer results, which continue to be impacted by the normalization of e-commerce traffic trend. In Q3, we launched our new pass program for men's, expanding our assortment beyond lounge and stretch, setting the foundation for continued growth with our men's business. In addition, in men's, we saw strength in [layering] (ph) pieces with items such as our shirt jacket and long sleeved nets. In both men's and women's, we saw strength in our sweaters, particularly as the quarter progressed and customers focused on buying out win our products. In addition, we have seen positive initial response to our cold weather accessories for both men and women with our new licensing partner at Amica. With respect to our wholesale performance, as part of Vince's 20th anniversary celebration, we introduced special capsule collections, which was showcased at select wholesale partners, who celebrated in our #ILoveVince campaign. We were thrilled with the results we saw, which we believe are a testament to the strength of the Vince brand. In fact, our collection was the best contemporary center stage acquisition to-date in sales for Nordstrom and we had our highest volume month at Nordstrom's New York City location since it opened in 2019. Turning to our stores. In Q3, our retail stores experienced an increase in foot traffic over 2021. There was notable strength in Washington D.C. and Boston locations, as well as Hawaii and Las Vegas, primarily attributable to traffic increases. We are pleased with our new store in the Seaport neighborhood in Boston, as well as a newly relocated store in Merrick Park and Coral Gables Park. In Q3, we also completed the successful relaunch of the Vince website, as well as our new customer data platform or CDP. Our new website is faster and enhances the customer mobile experience. We have been encouraged by the initial improvement we have seen with mobile conversion following the relaunch and look forward to benefiting from the capabilities the site provides, including its applications for enhanced personalization, particularly alongside the CDP. CDP allows us to capture detailed customer data across a variety of systems and provides an understanding of our customer at scale enabling us to better predict how they will shop with us in the future. With the improved capabilities, we will be able to enhance our marketing and better target and engage with both new and existing customers. We recently ran a small pilot leveraging CDP to target loyal customers, who had not engaged with Vince in the past 60-days. Through this campaign, we were able to provide our sales associates with valuable data and the ability to drive sales within a key customer cohort. This is just one small example of how we plan to leverage personalization, to enhance the relationship between our store associates and customers to drive increased frequency and spend over time. In addition, this proprietary first-party data is more efficient from a cost perspective and enables us to interact with our increasingly omnichannel customers and better understand their preferences to create a more personalized dialogue with them as they shop the brand. Turning to international. During Q3, we opened our first pilot store in China in late September. While early, we are pleased with the initial response we have seen. South Korea continues to be very strong and we are especially pleased with the reception of our 20th anniversary pop up in Seoul, Shinsegae. Also encouraging is our business in the United Kingdom, both in our wholly-owned retail store on Draycott Street, as well as our growing businesses in Harrods, Selfridges and Harvey Nichols. Finally, with respect to holiday, this year you again see a strong gifting focus in key areas of our assortment, including accessories as well as mix and cashmere. In light of the evolving competitive and consumer landscape we have observed, we made the strategic decision to pull forward a few key promotional events into October and launched our gifting assortment on the website two weeks earlier as well. While the environment has remained promotional through the start of the holiday season, we are pleased with the demand we are continuing to drive for the Vince brand. As we look ahead, while we expect to continue to navigate a challenging environment, we will remain agile and descipline, while focused on increasing efficiencies across our organization to position Vince for the long-term profitable growth. I want to thank all of our team members for their dedication and hard work as we enter a new chapter for Vince, fully and intently focused on capitalizing on the strength of the Vince brand. Thanks Jack. As Jack discussed our third quarter financial results were impacted by the wind down of the Rebecca Taylor business, as well as aggressive actions we have taken to reduce our events inventory levels, especially in light of the continued challenging macro environment. With respect to Rebecca Taylor, the business contributed $8.9 million in net sales for the quarter and we incurred charges of $11.1 million, related to the wind down activity, including the write-down of inventory, as well as accelerated operating lease amortization, accelerated depreciation and amortization, severance and other costs. We expect the wind down of Rebecca Taylor to be completed by the end of our fourth quarter. Turning now to our results in more detail. Total company net sales for the third quarter increased 12.7% to $98.6 million, compared to $87.5 million in the third quarter of fiscal 2021. The year-over-year increase was driven entirely by the Vince brand, which delivered third quarter consolidated net sales of $89.7 million, compared to $78.4 million in the same prior year period. The 14.4% increase was driven by our wholesale segment, which saw net sales increased 29.1%, exceeding our third quarter 2019 sales levels and offset the 3% decrease in our Vince direct-to-consumer segment sales as the continued normalization of e-commerce trends offset growth in our retail stores. Gross profit in the third quarter was $29.8 million or 30.2% of net sales, this compares to $42.1 million or 48.2% of net sales in the third quarter of last year. The decrease in the gross margin rate was primarily driven by the wind down of Rebecca Taylor business, which negatively impacted third quarter 2022 gross margin rate by 800 basis points. Also contributing to the decline in gross margin rate, as well was an unfavorable year-over-year adjustment to inventory reserves and an increase in promotional activity in the direct-to-consumer channel. Partially offset by favorable leveraging of distribution and other overhead costs. Selling, general and administrative expenses in the quarter was $39.2 million or 39.8% of net sales, as compared to $39 million or 44.6% of net sales for the third quarter of last year. The increase in SG&A dollars was driven by $4.4 million in expenses related to the wind down of the Rebecca Taylor business, which offset lower rent expense, lower consulting and other third-party costs, as well as lower marketing and lower incentive compensation expenses during the period. Operating loss for the third quarter, which includes the $11.1 million in costs associated with the wind down of the Rebecca Taylor business was $9.4 million, compared to operating income of $3.1 million in the same period last year. Income tax benefit for the third quarter was $6.6 million, as compared to $2.1 million in the same period last year. The non-cash tax benefit was a result of an annual non-cash deferred tax expense created by the amortization of indefinite-lived goodwill and intangible assets for tax, but not for book purposes. And the impact in the quarter of a change in the company's annual estimated effective tax rate thereon. A full-year non-cash tax expense is still expected for 2022. Net loss for the third quarter, which includes the impact of the charges associated with the wind down of the Rebecca Taylor business was $5.2 million or $0.43 loss per share, compared to a net income of $2.2 million or an $0.18 per share in the third quarter last year. Moving now to the balance sheet. Borrowings under our debt agreements totaled $125.5 million. We ended the quarter with availability of $26.8 million under our revolving credit facility. Moving to inventory, net inventory was $116.4 million at the end of the third quarter, as compared to $82 million at the end of the third quarter last year. The growth in inventory was driven by the increase of carryover pre-fall and fall assortments, compared to last year, as well as a higher investment in replenishment products, and higher product costs related to transportation and raw materials inflation. Despite actions taken, including increased promotional activity in Q3, we are entering Q4 with higher than normal inventory levels. We are actively reviewing our plans for fiscal 2023 and have reduced our inventory buys appropriately throughout the seasons of fiscal 2023, which we believe will better enable us to return to more normalized inventory levels in the second half of next year. We are laser focused on driving further efficiencies across our organization to enter fiscal 2023 in a healthier position enabling us to drive long-term profitable growth. This concludes our remarks. Thank you for joining us this morning. We look forward to speaking to you again on our fourth quarter call. Thank you all for joining. That does conclude today's call. Please have a lovely day, and you may now disconnect your line.
EarningCall_1476
Perfect. Hello, everyone. Thank you for joining us. This is Rachel Vatnsdal from the Life Science Tools and Diagnostics team here at JPMorgan. I am pleased to present Rainer Blair from the Danaher team. Today will be your normal session like the rest of the day, 40 minutes. The first 20 will be focused on the company’s presentation, followed by 20 minutes of Q&A. During Q&A, if you are joining us via webcast, feel free to submit your questions through that Q&A function online. And for those of you in the room, if you have a question, please raise your hand and we have mic runners throughout the room. So with that, thank you. Thank you, Rachel and then thank you to JPMorgan for hosting us today and hello to all of you. It’s great to see so many of you again in person and of course, also to those of you that were connected via the webcast. So it’s great to be here. Now before we get started, please have a look at our forward-looking statements advisory. Please feel free to review that at your convenience. Now before I get started, let me give you a quick overview about what I’ll talk about. First, I’ll give a quick current update on the fourth quarter and then I will talk about our separation of the Environmental and Applied Solutions Separation, where we see ourselves creating a great deal of shareholder value. And then I will talk about Danaher’s positioning post the EAS separation in 2024 and beyond as a science and technology leader with a focus on human health. Now the fourth quarter exceeded our expectations. You may have seen our announcement from yesterday after the close of the markets. We highlighted our fourth quarter that very strong finish to the fourth quarter in 2022, culminating in what was another tremendous year for Danaher. Now in the fourth quarter of 2022, our estimated core revenue growth was up high single-digits and that’s versus a guide of flat to slightly negative. We had high single-digit base business core revenue growth and that was as expected and then we had better-than-expected respiratory testing revenue at Cepheid with that coming in at over $1 billion for the fourth quarter. Now at the same time, we expect strong earnings and cash flow with adjusted operated profit margin exceeding our prior guidance. Now if we switch to EAS, our separation teams are in play. The work streams are progressing well and we expect to separate EAS by the fourth quarter of this year 2023. So, just a great quarter and a great way to finish 2022 for Danaher. Now as we think about the EAS separation, keep in mind that for both Danaher and EAS, the separation allows both companies to reach their full potential as separate and public companies. And we couldn’t be more excited for the teams about the opportunity and under the leadership of Jennifer Honeycutt, who will be the President and CEO of the new public entity. In fact, Jennifer has been with Danaher for over 20 years, is an exceptional DBS leader and highly experienced in M&A. And the business she will be running is shown here on the left it’s an outstanding $5 billion lineup of the leading franchises in the most attractive areas of water quality and product identification. In fact, what you have here are razor/razorblade business models with spec’d-in consumables supported by strong secular growth drivers, and in aggregate, a highly differentiated ESG positioning. And on the right, you will see our anticipated long-term performance of mid single-digit core revenue growth, recurring revenues of over 50% and adjusted EBITDA margins of 25% with very strong cash flow. And of course, now EAS will have the ability to deploy that capital with a bias towards M&A with meaningful cash deployments. At the same time, EAS of course will maintain at its foundation, the Danaher Business System and a commitment to continuous improvement with the strong execution that we have seen for a decade plus and the resulting market share gains. Now if you bring all this together, fantastic franchises, differentiated business models, fantastic ESG positioning, the ability to deploy cash to M&A, we see all of that driving tremendous shareholder value creation. So now if we fast forward, post EAS separation to Danaher in 2024 and beyond, how are we positioned at? Well, let’s start off with the fact that we are changing our segmentation of the business. We are extracting the biotechnology business from what is now then the legacy Life Science businesses and you will have three segments rather than two and of course, EAS, in this time period would also be – already be a separate public company. And so what you see here is that over the last years, we have dialed our portfolio into the most attractive end markets in Biotechnology, in Life Sciences and of course, in Diagnostics. And together, this has rerated our growth higher to high single-digits. That’s so important. And at the same time, you see that, that growth is balanced across the three segments. So, let’s have a look at those. In Biotechnology, you have got nearly a $9 billion franchise anchored by the bioprocessing business and growing at high single-digits long-term. If you look at the Life Sciences business line up here on the bottom with the logos, you can see those incredibly strong Life Science instrument companies in addition to the very strong genomics businesses, $7 billion of revenue, once again growing at high single-digits. Then you look at our Diagnostics businesses, here you are talking about an $11 billion segment that just in 2019 was $6.5 billion. And these businesses are aligned on the most important secular growth trends in Diagnostics. Let me give you some examples. For instance, the under-penetration of molecular diagnostics at the point of care, Cepheid is the gold standard with the largest installed base by a long shot, the deepest and widest menu in the world. So when you think about the fact that we continue to invest everyday in expanding that installed base and expanding the menu, that’s just an outstanding positioning. And I am sure you have all heard about the trend of healthcare decentralizing and moving outside of the core treatment centers, while at the same time, the automation of workflows to address the skilled labor shortage. Well, all of our diagnostic operating companies cover these trends, but particularly Beckman Coulter Diagnostics. So when you bring all this together, 2024, so post the EAS separation, what you have is a more focused, faster growing $26.5 billion science and technology powerhouse that’s focused on human health. Now also in 2024 and beyond, our businesses will be united by a common business model. These are razor/razorblade business models in mission-critical applications with spec’d in high-value consumables. And if you look to the right here, you see in 2024 and beyond, 80% of the revenue is recurring, up significantly from years past and also significantly reducing our cyclicality. Now at the same time, the customer intimacy we have developed with these mission-critical applications and the frequency of the interactions associated with these more consumable-oriented businesses, this has allowed us to inform our innovation engine. This allows us then to deploy our proprietary solutions at higher margins certainly, but also for share gain. So when you bring this all together and you think about these attractive end markets, these leading franchises, the power of the Danaher Business System, you can see how we bring lasting leverage to our growth and earnings trajectory. Now I mentioned that I would talk a little bit more about the biotechnology business, specifically bioprocessing the anchor asset in that new segment. And the reason I want to do that is, because of course, the acquisition of Cytiva has done so much to differentiate our capabilities there, but it’s also just such a great example of how Danaher creates value through scaled capital deployment. And this is a three-phase process for us this acquisition. And I have to tell you it starts with the team. I can’t say enough about our Cytiva team. They are innovative, they are motivated, they are highly qualified, and they are totally dedicated to our customers and patients. And it’s without them – it is with them and with that level of capability that we have been able to pull off this extraordinary acquisition. Let’s start with Phase 1 which is the carve-out, where over – where we exited over 200 transition service agreements. We hired, trained and deployed to the point of impact 3,000 associates. And we launched a new brand, which is already in the top echelon in terms of brand recognition in our industry. Now when you move to Phase 2, which is stand up and operate. Phase 1, carve out; Phase 2, stand up and operate. You can see that our Cytiva team embraced the Danaher Business System ran over 400 manufacturing Kaizens. So important of course to improve productivity, but also to increase our capacity during the critical time during the pandemic, during the critical time in the pandemic and at the same time, meaningfully improve the customer-facing metrics here with on-time delivery. Now in parallel, we continue to invest in the business over $1.5 billion in capacity expansions. I will talk about that with more detail in just a second. But by way of example, you can see here we have more than doubled the capacity of our single-use technology business. You may know that that’s one of the fastest growing segments within bioprocessing and that we are the largest player in single-use technologies as well. So that’s the standing up and operating part, but how are we doing financially? And if you look to the right here, I think the financials speak for themselves. First of all, we have more than doubled the sales of the business since acquisition. Keep in mind we closed this acquisition at the beginning of April of 2020. At the same time, we have been able to improve our competitive positioning allowing us to re-rate our long-term growth expectations of the business from what was originally 6% to 7% to now high single-digits and I think the return on invested capital says a lot. This is double-digit return on invested capital in such a short period of time and frankly exceeded all of our expectations. So, let’s move on then to Phase 3. What’s that all about? Well, Phase 3 is to bring together Cytiva and Pall into the biotechnology group. This is the premier bioprocessing business in the world. It’s unmatched. It has the broadest portfolio and the deepest portfolio across the bioprocessing workflow. And when I talk about broad, what does that mean? Well, it means that we can essentially provide you any individual product you might need to produce your biologic therapies, but we can also provide you the end-to-end solution. If you need us to build a plant with the clean rooms around it in the building and the IT infrastructure to run it properly, we can do that too. But what do I mean when I say the deepest portfolio? Well, the deepest portfolio is all about the number of modalities that we can address to meet the here and now, but also to the needs of the future. So for example, of course, we are leaders in protein therapeutics. So monoclonal antibody, antibody drug conjugates, bispecifics and the lot. But also in nucleic acid therapies, so gene, cell, mRNA, oligonucleotide, CRISPR-CAS9, we can provide the individual as well as the end-to-end solution to be able to develop at lab scale, scale up for clinical trials and ultimately produce at GMP quality levels for commercialization. That’s unique. That’s unique. Now we bring together what I consider the best and brightest and the best trained commercial and technical service teams in the world. And I’ll talk about the scale of these efforts in just a second. And the mission of this team is only one, to ensure that our customers have the best customer experience through the entire development cycle, so from R&D all the way through to commercialization. Now with these insights that we have in these mission-critical workflows, with the breadth that we now have in the portfolio, we are ultimately able to help our customers achieve that, which they ultimately care about, which is the best quality, the drugs need to be safe, quality is how that is characterized, the highest yields of the process. We want these drugs to find higher penetration and meet the patient’s needs around the world. That means we need to have the highest yield so that we can also deliver the lowest cost of ownership. And that’s what our innovation is. That’s what our teams are focusing on everyday. Now if we look a little bit further down here, we’re investing, of course, in capacity expansions. I mentioned that earlier. And that, of course, is important to meet the needs of the day and, of course, the needs of tomorrow. But as important in this industry is supply security. So we are able to now deliver that supply security in region – for region in all the major regions, including having redundancies in the supply chain to ensure that we can address worst-case scenarios some of which were arriving here during the pandemic in our industry as a whole. So we have made those investments, we continue to do, and we help to simplify our customer supply chains. Now we also, of course, continue to invest organically in the business. We’ve launched myriad innovations, as I’ve mentioned, to improve the productivity of the processes to improve the titers through the cell lines and cell culture media formulations that we deliver and any number of other examples. But at the same time, we continue to invest inorganically in this business to round up our competitive capabilities and our offering to our customers. Just to give you a couple of examples here, we have acquired Precision NanoSystems. These are smaller companies with big technology that allows us to deliver lipid nanoparticle capability to our customers. All of you are familiar with lipid nanoparticles because that’s what envelops nucleic acid, vaccines, such as mRNA. That’s what allows you to absorb the mRNA into your body and ultimately your cell. Aseptic fill/finish capability with the acquisition of NRx, so important with the sensitivity of nucleic acid therapeutics to have that aseptic capability – fill/finish capability in our organization. And then by way of my last example here, stable as well as transient cell line capabilities, so the cells that ultimately produce for instance, a gene therapy, either transient that’s one type of technology or stable, critically important to the future of these nucleic acid medicines. So here you see what we mean by scale over 16,000 associates in over 40 countries around the world, jumping out of bed, if you will, every morning, looking to help our customers get those therapeutics to the patients in need around the world via 36 global manufacturing sites. So this is what I mean about scale, capability in region, for region manufacturing in order to shorten supply chains and lead times, simplifying them from a complexity perspective and then ultimately providing unrivaled supply security. As importantly, over 20 R&D and innovation centers where we are working together on a daily basis with our customers, not just to meet the challenges of the day, of course, but also to understand the opportunities of tomorrow and the day after in innovating the next level of solutions. If you look to the right, you see the investments and several, like I said, $1.5 billion here in all the major product lines, certainly improving capacity, more than doubling capacity, but also slashing our lead times for competitive advantage and once again, to be closer to our customers. So at the heart of world-class execution at Danaher is the Danaher Business System. This is how we operate. This is how we execute across our businesses, all the operating companies. And that will be the case for EAS in the future as well as it is for Danaher. And in blue, you see our core values and our shared purpose helping realize life’s potential, which is the basis for over the competitive advantage, sustainable and differentiated that we have refined over decades. The Danaher Business System, it’s not just a collection of tools. It’s a culture. It’s who we are, and it’s how we do what we do. It’s why we’re different. So let me give you some proof points. I mentioned that I talk about the Life Science Instrument businesses. And on the right side, you see here from 2012 to 2016, those businesses were growing in the low to mid-single digits. And so we applied here the power of the Danaher Business System to a group of businesses in very attractive end markets to sustainably improve our innovation processes. And on the left, you see examples of that, the problem to portfolio tool that SCIEX deployed to better understand the most material and critical pain points of our customers, resulting in the launch of the 7600 ZenoTOF, you’re all aware of the importance of proteomic research. The 7600 ZenoTOF identifies and quantifies more proteins than any other platform in the world. The 7500 Triple Quad that was launched in parallel is the most sensitive mass spectrometer, allowing for a far better bioanalysis in the ultimate development of drugs. And this has resulted to 40% of SCIEX’s growth attributed to new products, and you can see a sustained improvement in growth from mid to high single digits on the right. You think about Beckman Coulter Life Sciences, launched over 30 products since 2018. That’s an order of magnitude, more order of magnitude more than the equivalent prior period through using the accelerated product development tool. And then lastly, and this is one I’m super excited about. Of course, I’m excited about all of them, but I’m super excited about the improvement here at Leica Microsystems. When you launch a breakthrough in Life Sciences, a critical factor is how quickly will it be adopted. Scientists, understandably are very conservative, and so it’s so critical to be able to, after launch, have a high adoption rate to accelerate your growth. And so we developed a product launch excellence tool here. And Leica Microsystem launched a product called Mica. And it’s a microscope that combines widefield microscopy with confocal microscopy in a form factor in price that allows principal investigators to do high-resolution live cell experiments in their own lab as opposed to having to send those cells to the core lab with all the trouble you can imagine that’s associated with that. We’ve had an extraordinary uptake of this amazing breakthrough. It’s, of course, increased the size of the market by now bringing these solutions to principal investigators versus the fewer core labs. And you can see an increase in revenue of over 40% in new products in the last 3 years. So you can see the power of the Danaher Business System to sustainably improve processes and growth in this example in the Life Science Instrument Group. And it’s one of the reasons why this business has been growing so strongly here, including the fourth quarter here of 2022. Now let’s switch gears and talk about sustainability. It’s so important, and it’s getting more important every day. And as a result of that, it’s, of course, also a priority for Danaher. Now we define our sustainability activities along three categories: team, innovation and environment. You can see that down in the middle. And as you likely saw one of our core values is the best team wins. And so for us, building the best team means building a diverse team: more resilient, more innovative and more motivated. And as such, 75% of our recent hires are diverse. If we look at innovation, of course, innovation, as I just spoke about, is central to our business. It’s what we do to help improve lives but we also want to help improve the planet here. And so what we’ve done is we’ve integrated sustainable design practices in our R&D processes. We’ve upped our R&D investment by 30% to have an outsized impact here as well. And then lastly, if we think about the environment, we’ve signed up for over 50% reduction in greenhouse gas emissions, not by 2050. But by 2032, concrete steps to deliver real progress in greenhouse gas emissions by Danaher and if you are interested in hearing more about our sustainability journey and the progress that we’re making. We’ve just published our sustainability report 2022 in the fourth quarter, and you can download that from our website. Now let’s bring it all together. What does all this mean? Once again, post the EAS spin and Danaher 2024 and beyond, we are rerating both our growth as well as our margin profile higher. So our growth from mid-single digits plus to high single digits. And if we look underneath the hood, how is that? Well, here you see it, the scaled leading franchise in bioprocessing, $8.8 billion, the combination of Cytiva and Pall growing at high single digits. The gold standard at the point of care for molecular testing which will represent more than 10% of Danaher, growing low double digits. Then you have our genomic – excellent genomic franchise is growing well into the double digits and are very strong, and I just talked about those Life Science Instrument and Clinical Diagnostics businesses growing at mid-single digits plus. So you bring all that together, that’s your high single-digit growth rate, and we’ve re-rated our fall-through from 30% to 35% to now 35% to 40%. And you couple that with our very strong free cash flow conversion, and you channel that to capital allocation with a bias to M&A, you see why we’re so confident in our double-digit plus EPS growth trajectory and the power of the compounding returns that, that implies. So to wrap up, once more, just the key takeaways. Post the EAS separation, so think 2024 and beyond, we have differentiated positions in the most attractive areas of Biotechnology, Life Sciences and Diagnostics. We’re enhancing our growth trajectory and long-term competitive advantage every day through investments in innovation and capacity where appropriate and M&A. And lastly, we have rerated both our long-term growth and margin profiles higher, driven by the power of the Danaher Business System. Thank you. [Operator Instructions] So first off, congratulations on the preannouncement, high single digits core and then high single-digit base business, well above expectations. A lot of that was driven by respiratory season and outpaced growth at Cepheid. But just wondering if you could walk us through, were there any other businesses that grew above your expectations internally. Bioprocessing is obviously an area of interest for most of us in the room. So can you walk us through what are some of the trends you saw in bioprocessing? Sure. So I mean we’re just closing the books now as you can imagine, but I think I can give you some color here. First of all, I would tell you that bioprocessing grew as expected and we closed the year at high-single digits growth, which is something that I have been communicating as our expectation, and that’s where we are. As we think about our Life Science Instrument Group, it grew in the high-single digits with some of the operating companies that you just saw well into the teens like the fleet average in the high-single digits, also as expected, very strong growth. If we move to Diagnostics briefly. Here, we saw of course, Cepheid crushing it with the beat. But then also, we saw Leica Biosystems and Radiometer businesses growing into the high single, low-double digits. And then lastly, Beckman Coulter Diagnostics, there we did see the impact of the China reopening with an impact on patient volumes, but really at the margin. So, in aggregate, life or – Diagnostics of course, together with Cepheid, outperforming our expectations. Great to hear a really strong performance across the board there. So, maybe just to get into some of this bioprocessing dynamic. So specifically, you laid out recently a range of outcomes for that non-COVID bioprocessing heading to next year. You said it could either be in that high-single digit to low-double digit range, which is our longer term growth profile that you have historically pointed to or it could grow mid-teens in line with the 3-year CAGR that we have seen just off the robust growth we have had in recent years. So, first off, can you give us an update on what you are seeing from this destocking dynamic at some of those COVID customers that have bagged on COVID and that market just hasn’t come to fruition? And then how is that – how are those conversations translating into where you are thinking bioprocessing will shake up on ‘23? So, regarding the stocking dynamic in bioprocessing, I think we have talked about the fact that we actually didn’t see broad-based inventory builds across the breadth of the bioprocessing market. Where we have seen them, it was related to larger players with larger COVID related, so think vaccines or therapeutics programs that ultimately either didn’t come to fruition or the uptake, as you can imagine, with some of the vaccine uptake that we have seen relatively low, simply didn’t generate the volumes. And what we are seeing there is that these customers with whom we are in a dialogue with regularly are starting to burn down those inventories because they are applicable to other programs that we have. So, that is going as expected. And we have talked about that taking a couple of quarters, and I think that’s our view there as well. And as we think about the non-COVID business, just back to the fourth quarter, we saw that growing 20% plus as well in the fourth quarter. So, what we are doing right now, and this is that time of year for us, so it’s not unusual. We are in a dialogue with our customers nailing down with them, their production plans for 2023. Those roll-ups are in process. The team is working it as we speak. And actually, I will be updating all of you here during our earnings call on January 24, so just a couple of weeks away here on where all that shakes out for ‘23. Great. Maybe just spending a moment here on COVID vaccines and therapeutics and sort of kind of touching on it already, can you just talk to us about, were you able to hit that $800 million in COVID revenues for vaccines and therapeutics this year. And then how does that translate into your confidence for that $500 million last – or for the upcoming year? Obviously, that’s been a bit of a dynamic market. So, what gives you confidence that you are able to reach that $500 million next year? So, first, we did hit the $800 million slightly more in the COVID business and bioprocessing for 2022. We today, are talking about the $500 million number for next year. And we are, as I have suggested a minute ago, in dialogue with our customers today regarding their production plans in order then to come to a final perspective on 2023. And wish to share that here in a couple of weeks. Perfect. And then there has been some questions on this pharma and biotech pipeline. Just given funding concerns, mAbs, biosimilars as well. You flagged during your Analyst Day this fall that you expect mAbs to grow double-digit CAGR in the next 5 years, and then for biosimilars to increase 20% from 2022 through 2027. So, can you talk through some of the data points and what gives you confidence that, that long-term funnel that you are going to be able to support long-term? Sure. So, I mean if we start with the funnel and let’s say, monoclonal antibodies, the number of projects in that funnel has increased by 50% here in the last 5 years. This is a product class, which is now in its 25th year to 30th year and efficacy and the understanding of these molecules has increased so much over the years that we continue to expect that pipeline to progress through the various clinical phases and then ultimately be commercialized. Monoclonal antibodies are here to stay for the long-term and are real growth driver. And of course, they are by far, by far, the largest segment or modality in the drug development pipeline. And that’s what gives us the confidence to do that. And of course, some of the investments I have shared with you today are essentially catalyzed by our confidence in that funnel. And then if you think about the next-generation drugs, gene and cell therapy, mRNA, and of course, gene editing with CRISPR-Cas9 and so forth. Those are in their early stages. It’s a relatively small market, but we see that the development funnel has increased by an order of magnitude. So, 10x in the last 5 years, and we see these projects progressing through the drug development phases and sometimes at an accelerated rate. And hopefully in the next year here, we will also hear about additional approvals in those drug classes. And those also not only inspire us in terms of what’s possible in terms of curing patients, but also in terms of the health of this business, as the critical mass of those therapies picks up here over time. Helpful. Maybe shifting over to some of this instrument strength that we have been seeing across the sector, can you just give us an update on how you are thinking about that instrument market. The acceleration that we saw this year, was a lot of that just underlying market growth with some of that share shift? And then how do you see that translating into 2023 as the comps get much more difficult? Sure. So, as we think about 2022 as a starter, it has been a strong funding environment. There is no question that the market overall is very healthy. We in particular, have been able to benefit from this. I just talked through some of the innovations that we were able to launch. So, together with this healthy funding environment, our very strong growth, and we think share gain is based on the new product development cycle on top of that. And then as we get into 2023, as you can imagine, I will talk to you more about that here in a couple of weeks, right. But we continue to believe that we are in an advantaged position there. Maybe shifting over to China, so you mentioned during your earlier comments about Beckman having a little bit of a headwind there. Can you just talk to us about what you are seeing in the China market as a whole? You were able to really grow in 2Q despite lockdowns. But this is a bit of a different scenario with some of the outbreaks that we are seeing, especially on the personnel side. So, can you walk through what that means from a patient volume perspective and just your ability to be successful and grow in China in the near-term here? Sure. Well, first of all, it’s difficult as this situation is in China for the people in China. One has to really feel for what’s going on there. Ultimately, this is going to result in a more robust growth outlook for China, which we continue to be very positive on. So, we do view this as a phenomenon, which may take a quarter or two quarters in order to shake out. But what we have seen, and even into the fourth quarter, for instance, our Life Science Instruments business continues to be very strong. So, stepping back from what is a turbulent, but we hope brief time here in China, we expect the markets perhaps even to release pent-up demand in the second half of 2023, that’s unclear at this stage. But also, in the long-term, we remain bullish on China. The needs of the Chinese population from a healthcare perspective, we are just scratching the surface there, and we expect China to be a growth market for the long-term. Helpful. And then in terms of your long-term guide, obviously, this portfolio has gone under a significant transformation in the last decade here with Fortive and then with Envista, acquiring Aldevron, Cytiva and then better physician diagnostics franchise coming out of the pandemic as well. So, you guided to high-single digits long-term. And so that’s post-spin EAS, and then some of your peers have also guided to high-single digits, but that’s inclusive of some of these lower growing businesses. So, can you kind of talk through the dynamics there? And then what would it take to really push Danaher into a double digit growth scenario over the next few years? Well, first of all, we believe really when we talk about long-term, we are not talking about 3 months, 6 months, 12 months, right. We are talking about 3 years, 5 years, 7 years. And we think that high-single digit growth at the scale of the businesses that we are talking about is the sweet spot in terms of how to think about that long-term. Can we imagine years that might be stronger, we can, absolutely. And will there be years perhaps when the step is taken back, that could be too. But we do believe in the long-term that a high-single digit growth rate for a $26.5 billion franchise is a significant vote of confidence in the strength of the portfolio, the differentiation of those businesses and the power of the Danaher Business System. Great. And then kind of going off of that, obviously, this is not your first time spinning out of business. So, can you just talk about what did you and the rest of the management team really learned from spinning off Envista and Fortive? And then how will those learnings really impact the EAS spin? Well, there has been a myriad learnings, as you can imagine, we have developed quite a bit of capability here in terms of the standard work. So, if you will, the standard operating procedures that you go through in order to efficiently and appropriately be able to separate a business like this. And I will tell you the biggest equation, as you can imagine, besides tax and behind – besides all these other important details, is the talent, right. So, we have really learned how to ensure that our talent sees the opportunity of the separation. You can imagine some meet this kind of news initially with some trepidation after having been long-term Danaher associates, but when they recognize that the future where they are now positioned really as a differentiated business with such a strong ESG profile, an attractive set of franchises and the ability to deploy the cash flow that they generate, not the Life Sciences or Diagnostics, but to their own businesses, is an incredibly attractive proposition to them. And so if I had to summarize the biggest learnings and underline at 3x, it’s, make sure that you communicate well to the talent, the opportunity, not just for the business, but for them as individuals. And then you see the great leadership that we have appointed there to be the President and CEO with Jennifer Honeycutt, that’s what we have done in each one of these separations and that has been incredibly important.
EarningCall_1477
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 Steelcase Third Quarter Fiscal 2023 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, Rob. Good morning, everyone. Thank you for joining us for the recap of our third quarter fiscal 2023 financial results. Here with me today are Sara Armbruster, our President and Chief Executive Officer, and Dave Sylvester, our Senior Vice President and Chief Financial Officer. Our third quarter earnings release, which crossed the wires yesterday, is accessible on our website. This conference call is being webcast and this webcast is a copyrighted production of Steelcase Inc. A replay of this webcast will be posted through ir.steelcase.com later today. Our discussion today may include references to non-GAAP financial measures and forward-looking statements. Reconciliations to the most comparable GAAP measures and details regarding the risks associated with the use of forward-looking statements are included in our earnings release, and we are incorporating by reference into this conference call the text of our Safe Harbor statement included in the release. Thanks, Mike. And hello, everyone, and thanks for joining today's call. Our third quarter results were about what we expected as both revenue and EPS finished within the guidance range we provided in September, and we feel good about that given the challenging environment. Our corporate clients have slowed investment in office space as they face a potential recession and economic uncertainty in many parts of the world, and this has caused our demand levels to soften. We started to see our order pattern flow down at the end of Q2, and this continued throughout our third quarter. On the supply side, inflation persists and our supply chain partners continue to struggle to find enough labor. Yet, in Q3, we delivered results within our expectations by executing against our three strategic pillars and by taking multiple additional actions. Our progress in diversifying the customer and market segments we serve helped offset softness in the corporate market. We continued to implement our pricing action successfully, we managed operating expenses relentlessly, and we mitigated the impact of supply chain disruptions with numerous adjustments in our operations. I also want to note that, in the face of a challenging environment, our EMEA business contributed to our results by delivering $4 million of operating income this quarter. I'm proud of our organization's commitment to deliver solid results despite the headwinds that we're navigating. Dave will share more about current demand patterns, and he'll cover expectations for next quarter and how we're thinking about fiscal 2024 in a minute, and I want to share how we're thinking about the path forward over the next few years. In recent quarters, we've intensified our focus around three primary objectives – leading the hybrid work transformation, diversifying the markets and customers we serve, and improving our profitability. And today, I'd like to paint a more detailed picture of how we see the market landscape evolving and why we think pursuing these three objectives will position us to win with customers and drive improved financial results. We're not ready to share long-term targets right now, but we believe our strategy can deliver significant earnings improvement over the coming years. There's no disputing that our core market, traditionally driven by large corporate customers with offices typically in big cities, is under pressure, especially in the Americas. We believe demand will improve from current levels as recessionary concerns weighing on CEO confidence abate and more customers decide to invest in their offices to support hybrid work strategies. Because it's clear that a more flexible model of work is here to stay, it's wise for us to imagine a contract office furniture market in which customers may invest less in office space and invest in that space differently than prior to the pandemic. And it's essential that we continue to evolve our company to meet customer needs and to compete successfully in that environment. So, there are two important things at play here. First, we don't know what the ultimate size of the contract Americas office furniture market might be as large companies implement hybrid work strategies. But to give you one scenario, if you model the industry recovery stabilizing at a level that's 20% to 25% below pre-pandemic levels, that would obviously create a revenue gap for us to fill. Second, we believe that no matter how the level of demand from corporate customers changes, the nature of that demand, the ways in which they'll support their employees and work is changing. The types of solutions they need today and for the future are different than prior to the pandemic. So, what does this mean for Steelcase? Well, not only do we believe we can expand other parts of our business to fill a hole that may be created by reduced corporate customer demand, we're also confident in our ability to bring insights based innovation to corporate customers and to evolve our portfolio to serve those customers' changing needs. Industry leaders face market shifts and adapt. That's what Steelcase has done for 110 years and that's what we intend to continue to do. And this brings me to the three pillars that we've been sharing with you for the last few quarters. So, first, we intend to lead the hybrid work transformation. Corporate customers are grappling with profound changes in work and the workplace. And our insight and innovation matter now more than ever. That's why we remained invested in our strategies to evolve our product portfolio and our go-to-market model even during the challenges of the past nearly three years. Our product development investment is focused on the most critical needs for hybrid work, such as great hybrid collaboration experiences and new ways of delivering privacy in the workplace. We've engaged customers in our research and introduced solutions based on that research. These products such as Flex Personal Spaces, Flex Active Frame, Everwall and Orangebox pods have reimagined both individual workspaces and collaborative spaces and we plan to introduce more innovative solutions next year. We believe this expanding product portfolio reinforces our position as a leader, ready to help corporate customers understand the future of work and equip their spaces for the ways work is changing. And our relentless focus on supporting customer needs has driven increased market share. Over the past year, as compared to this month, we've grown faster than our industry. We're also redesigning our go-to-market model to be more effective and more efficient. We've shifted sales resources to market segments that provide attractive opportunities for growth, and we continue to align sales roles and resources to support our strategy. The ways in which we engage customers are changing too, and we're delivering high impact customer experiences in more local, accessible and tailored ways. This will enable significantly more customers and influencers to experience who we are and what we have to offer, both in person and virtually. These products and go-to-market innovations position us to maintain a healthy and leading corporate business. Our strategy to lead the hybrid work transformation is focused on gaining a higher share of the corporate market, and we also see tremendous opportunity to expand our business beyond that market segment. So our second pillar targets continued aggressive diversification of the customer and market segments we serve. We believe this also will contribute to offsetting any decline in the corporate market, and potentially enable us to more than offset any decline. Our diversification has been centered around the education mid-market and consumer markets. In education, year-to-date revenue at our Smith System business is approximately 50% about the same point in fiscal 2020 and we've doubled the business since our acquisition, which is ahead of our initial plan. Smith System is a leader in providing solutions for K-12 classrooms and we're very proud of their progress. We also believe higher education, which has been an important market focus of ours, provides additional strong growth potential globally. Our education business in Asia Pacific, for example, has seen good success over the past several years. We expect it will be up approximately 50% this year as compared to fiscal 2020 and we expect that growth to continue. We're also investing to serve the mid-market segment. which typically consists of smaller to mid-size businesses in a more tailored and effective manner. AMQ, which delivers the customer experience smaller companies desire, geared towards speed, simplicity and support, has driven strong revenue growth in the Americas and year-to-date is approximately 20% above fiscal 2020. This business has more than doubled since our acquisition. We've invested this year in operational enhancements at AMQ to accelerate speed of delivery, and we have rolled out an enhanced customer experience that leverages new digital tools to allow AMQ to better reach and serve the mid-market segment. The consumer market represents additional diversification potential, and I'm really excited about our progress here. In the Americas, our consumer business revenue is up over 300% year-to-date compared to fiscal 2020, and we have additional opportunities to grow through retail partners like West Elm and Best Buy. And around the world, we've had solid success initiating and growing consumer businesses. We also expect to grow as we target specific consumer niches, such as eSports, where products like Gesture, provide all day work and play performance. There is significant potential to bring our insights-based innovation and Steelcase quality to consumers who are looking for a higher combination of design, quality and performance to support their work at home. The third pillar of our strategy is to increase our profitability. We are working actively on multiple fronts to drive improvement. First, as we've discussed continuously over the past two years, our industry has experienced extraordinary inflation, and we have responded by taking significant pricing actions. While Q3 reflected year-over-year net pricing benefits for the second consecutive quarter, cumulative inflation still exceeds cumulative pricing benefits. Once these fully offset, and if we can earn margin on the inflation as we intend, we could see a benefit to earnings. Beyond pricing, we've always pursued annual cost improvements. The current environment, however, requires a more aggressive focus on improving our cost structure. So, for the past several months, we've been working on three additional initiatives. First is an evolution of our operational model in the Americas, which include modernizing our footprint, optimizing our product portfolio to reduce operational complexity, and increasing our agility to mitigate supply chain challenges. This work is bearing fruit, with one example being that in October, we were able to close our Denver regional distribution center. Two other examples include investment in new manufacturing technologies that will significantly improve our efficiency and reduce required floor space and the consolidation of similar production processes into one facility which improves our efficiency and reduces redundant equipment. We are also insourcing certain parts and finished goods which provides cost reduction and efficiency gains. These moves are examples of the kinds of action we're taking to streamline operations and reduce costs. The second initiative is focused on business process transformation, which is our effort to design more effective and efficient business processes, while updating our enterprise resource planning system. We are at the beginning of this multi-year effort, but we expect great benefits as we adopt best practices and reduced customization of our business processes and supporting systems. Our teams are working with external consultants to ensure we achieve the maximum gains at the appropriate level of investment as we transition to our future platform. The third initiative is to capture certain efficiencies as we redesign our go-to-market approach, which I mentioned earlier. Our Grand Rapids customer experience will continue to be an important component of our customer engagement strategy. Yet, by engaging with more customers where they are, we can ramp down our customer aviation investment as we adjust our approach. This move not only will reduce our costs and free up capital for potential deployment to better support our go-forward strategy, but it will also reduce our carbon footprint. Dave will cover more specific financial implications of the aviation decision in a minute. Before Dave gets to that, I'd like to summarize why the future is exciting to us. The world is experiencing profound change, and this profound change just reaffirms our aspiration to help people do their best work by creating places that work better. We believe better is possible. And we believe in our path forward. We believe our initiatives to diversify the customer and market segments we serve, along with our investments to increase our market share by leading the hybrid transformation of traditional corporate office space work, have the potential to offset the volume gap we may face from any decline in the corporate market. On the profitability front, we expect to provide more details regarding the anticipated benefits and timelines for our initiatives as our plans develop more fully over the coming quarters. The key point today is that we believe there is the potential to drive meaningfully higher levels of profitability. Fully implemented, we believe our strategy and initiatives could deliver results above our pre-pandemic revenue level of $3.7 billion and operating margin of 6.9%. We'll have more to say in the coming quarters as we assess the timing and ultimate magnitude of these initiatives. Thank you, Sara. And good morning, everyone. My comments today will provide some color around our third quarter results, including a comparison to the outlook we provided in September, as well as some comments regarding demand patterns, our recent actions, the balance sheet and our cash flow. I will also cover the outlook for the fourth quarter and share some preliminary thoughts about fiscal 2024. As Sara said, our revenue and adjusted earnings in the third quarter were in line with our expectations. What's notable about our performance is that we delivered the results despite a projected $7 million gain from the sale of property being delayed to the fourth quarter, the continuation of supply chain challenges and the internal disruption of implementing headcount reductions, which we previously announced and completed in the quarter. For revenue, we grew 13% organically compared to the prior year, which was driven by all segments. We estimate year-over-year pricing benefits approximated $85 million and volume growth was modest. Requested delivery dates by our customers remain relatively extended, despite many of our core products being available within standard lead times. Thus, the softening order patterns we experienced in the quarter had a small impact on our top line. As it relates to adjusted earnings, our operating expenses were lower than our projection, and this helped to offset gross margin coming in slightly lower than the range we projected, which was due to some operational inefficiencies. With respect to operating expenses, we implemented the previously announced actions to reduce headcount in the Americas and corporate functions, which resulted in approximately $11 million of restructuring costs in the quarter and is expected to lower our cost structure by approximately $19 million on an annualized basis. As part of this work, we also eliminated more than 50 open job requisitions, many of which were replacement reqs and were part of our cost structure earlier in the year. Beyond these actions, we continue to look for additional opportunities to pull back, pause and/or eliminate spending that is not highly aligned with our go-forward strategy. To support this endeavor, we recently completed a review of our functional spending that was summarized using a Xero-based approach. And through this work, we identified additional opportunities to potentially reduce or reallocate spending next year. Also in connection with the refinement of our go-to-market strategy in the Americas that Sara just summarized, we also made the difficult decision to wind down customer aviation and sell our aircraft over the coming months. We expect this action will result in approximately $3 million of restructuring costs in the fourth quarter and generate approximately $11 million of annualized savings once fully implemented in the first quarter of fiscal 2024. In addition, we expect to use the proceeds from the sale of our aircraft to pay off the related financing, which matures on May 1, 2023. For cash flow and the balance sheet, we ended the quarter with $55 million in cash and $216 million in total liquidity, which was a few million dollars higher than Q2. During the third quarter, we generated $60 million of adjusted EBITDA, a $9 million improvement in working capital, and approximately $17 million of other net positive cash impacts, which collectively funded $14 million in capital expenditures, $11 million of restructuring costs, $12 million of dividend payments, and $46 million of net repayments under our credit facility. At the end of the quarter, our total debt aggregated $516 million, including $34 million of remaining borrowings under our credit facility and $33 million of term debt related to our aircraft financing. We continue to project paying off the credit facility by the end of the fourth quarter. And with the sale of our aircraft, we expect to pay off the related financing, which will reduce our long term debt to $450 million, which represents our long term notes. At the end of the third quarter, our ratio of trailing four quarter debt to adjusted EBITDA approximated 2.9 times, and it's less than two times on a net basis taking into consideration our liquidity. Moving to orders, we saw third quarter orders decline 17% as compared to the prior year, which was driven by broad-based declines across all segments, including 16% in the Americas, 10% in EMEA, and 37% in the other category. In the Americas, we estimate volume declined by approximately 30% year-over-year, partially offset by more than 10% growth due to pricing benefits. Compared to earlier this year, demand patterns are being impacted by softening industry trends, which we believe are linked to reduced sentiment related to macroeconomic and geopolitical concerns. In addition, many customers remain undecided on their strategies to support hybrid work. Across the quarter, the year-over-year comparisons varied significantly. Recall that we disclosed last quarter that our consolidated orders were down 20% through the first three weeks of September versus the prior year. From there, the full month of September declined 16% year-over-year, followed by declines of 13% in October and 24% in November. And through the first three weeks of December, we've seen a decline of approximately 6% compared to the prior year. While order patterns have varied and shown weakness compared to earlier in the year, new project opportunity creation has improved, especially in the Americas, where we have now seen six consecutive months of year-over-year growth. In addition, we are encouraged by the news that some large design firms are hiring, and one of them is returning to their offices more significantly. Shifting to the fourth quarter outlook, we expect to report revenue within the range of $740 million to $765 million, which is approximately flat with the prior year. And we expect to report adjusted earnings per share of between $0.11 and $0.15, which represents a significant improvement over the breakeven adjusted EPS we had in the prior year. In addition to the projected range of revenue, the earnings estimate includes gross margin of approximately 29%, which is nearly 300 basis points higher than the prior year and includes projected year-over-year pricing benefits net of inflation of approximately $65 million. In addition, we are projecting operating expenses of between $195 million to $200 million, which includes $6.5 million of amortization related to purchased intangible assets and approximately $10 million of expected gains from the sale of fixed assets. Lastly, we expect interest expense and other non-operating items to net to approximately $5 million of expense, and we are projecting an effective tax rate of approximately 28%. As we look beyond the fourth quarter and into fiscal year 2024, there are several things to consider. First, we are targeting to more fully realize the pricing benefits from the actions we've taken to offset the extraordinary inflation over the last seven quarters, which we estimate totals approximately $340 million on a cumulative basis. In addition, we are targeting additional gross margin improvement next year from benefits related to the strategic initiatives and actions Sara summarized earlier. And across operations more broadly, we're targeting to offset employee merit pay increases, higher health care costs and some investments in our strategy with benefits from our recurring operational cost reduction activities and fewer supply chain disruptions. For operating expenses, we are planning a similar approach, wherein we will target to offset our incremental investments with the savings from the actions I summarized at the beginning of my comments. The big question for next year is volume. And the questions include how quickly and by how much our revenue might benefit from the improving opportunity creation, how quickly or slowly the recessionary concerns abate, and whether and how fast return to office patterns increase and/or at what pace do our clients invest more significantly to support their strategies for hybrid work? These are all questions for which there aren't clear answers at this point. What is clear is that if the demand environment worsens, we will continue managing our cost structure to target returns for shareholders while investing in our future. And what is also clear is that, if the demand environment improves, we will target a relatively strong contribution margin from the volume growth as we remain partially invested for a recovery and we'll be cautious about increasing our cost structure during its early stages. I know that doesn't paint a clear picture of a targeted range of revenue and earnings for next year, but I wanted to at least share some context with you about how we're thinking about managing through the uncertainty. Longer term, as Sara detailed, we expect our strategy to deliver meaningful earnings improvement. We acknowledge there is an increasing probability that the Americas industry will be smaller compared to pre-pandemic levels once we are beyond the current environment and settle into a future state. However, we are targeting to offset the potential impact on our revenue through our strategies to lead the hybrid transformation and further diversify our revenue base. In addition, we believe our initiatives to improve profitability have the potential to fund additional investments in our strategy and workforce, as well as help enable meaningfully higher returns to shareholders. And we look forward to laying out that path with even more clarity in the quarters to come. So while we're staying very focused on managing through the current environment, we are optimistic about driving improved financial results as we execute our strategy. Maybe if we could start with the diversifying end markets strategy. I know it's early stages, and you mentioned timing and quantification down the road. Can you give us any idea how big those kind of three buckets are today? I think you mentioned education, mid-market and consumer. What percentage of revenue are they today? And you mentioned timeline down the road. Any color for potential goals there that you can share at this point? Well, you might want to take some of that conversation offline with Mike, where I think you guys could go back and look at initially Ks when we announced the acquisitions. I think we included the initial size of those organizations when we acquired them, and Sara commented on how we've more than doubled or tripled some of those businesses since the acquisition date. So I think you'll get a sense of where they stand today, which might help. But the way I'll answer your question is we don't know how much smaller the industry might be. There, I used a reference of 20% to 25%, trying to at least give some context behind how we're modeling different scenarios. If you imagine a 25% downturn on our FY 2020 Americas revenue, you kind of come up with several hundred million dollars, $400 million, $500 million, let's say. And we see the potential for our diversification initiatives, as well as gaining share in a smaller industry as a way to offset that kind of a decline. Now, I'm not saying that that's what we're predicting because we really don't know how the industry is going to look in two or three years. But to give you kind of a sense of the magnitude of our growth strategies and diversifying our revenue as well as our intention to target a higher share in the industry go-forward, we kind of shared that context. But hopefully that helps, Reuben. Well, it's down significantly. What we've been tracking more closely, I would say, are the order patterns in our core business and how it stands to pre-pandemic levels. And it's been tracking as low as in the 35% range versus pre-pandemic levels at the initial part of the pandemic. It improved from there over the kind of interim year, year-and-a-half to more in the 20s, 20 versus pre pandemic levels. And it since has worsened with how the industry has softened and our order patterns have followed. On the profitability initiatives, I guess, can you help us with a bridge for this coming year? You have $30 million in cost savings between the aviation and your announcements last quarter. It sounds like these incremental – or these initiatives today are incremental to that $30 million, and then you've got some price costs that you're still catching up. And I know you talked about the first quarter, but can you kind of put all those together for what kind of tailwinds you have on the profit line that might offset or more than offset some of the volume headwinds? Yeah, we'll try to help you with that a little bit more detailed in 90 days. But you've got the bridge, you just don't have the quantifications. And unfortunately, we're not ready to share those today. But the way I'm thinking about it is kind of how you summarized. I think this year, when you take our fourth quarter guidance and you reverse engineer it to get to adjusted operating income, you can kind of conclude that we're targeting in an $80 million range of adjusted operating income this year. From there, I would add targeted pricing benefits for next year and savings in our factories from the initiatives that Sara summarized. Now, we're going to have investments in merits and investments in health care costs and other parts of our strategy. So hopefully, that will net to something positive. But we're not through our planning process at this point. And similarly, on the operating expense side, we will have investments in our people for merits and healthcare costs, and we will continue to make investments in our strategy. But we'll have savings from the initiatives I summarized to largely offset those. From there, the big question is volume. And that's where we are just planning for different scenarios. And one of those scenarios is that it gets better because we do have opportunity creation that is meaningfully improving for six consecutive months. And we've been in this situation for almost three years. And we can feel and sense that our clients want to get back to the office. They just don't know exactly how to think about their work environments. And so, we're helping them with that. And it just feels like more and more companies are getting beyond the initial efforts of asking and offering free lunches and the like, and starting to think a little bit more aggressively about how they get their people back. But we've been here before, Reuben, right? We were here a year ago. We thought return to office would accelerate more meaningfully and we found ourselves in an environment with different variants of COVID and the like. So, I just don't have a view on volume yet for next year. I'm going to sneak one more in if I can. Going back to the diversifying end markets, Sara, can you maybe elaborate on how exactly – some of those markets, there are already some players and trends there? Do you need to make more acquisitions to get bigger in those areas? Or can you do this organically with what you have and just moving some of your investments to grow in those areas? I would say, first of all, with respect to opportunities to look at acquisitions, we always keep our eyes open. But I would say, at this point, we feel that we've made a number of significant investments with the acquisition of companies like Smith System to really help accelerate that diversification strategy. And as you just alluded to in your question, yes, it's also true that, in addition, we have been very intentional about shifting resources, dollars, talents, from some parts of our business into those areas that we want to grow dramatically, to help accelerate that organically. So, I think I would say where we sit today, we feel quite good about how we're positioned to move those strategies forward. Of course, we're thinking about additional investments we need to make organically, things we need to do to continue to capitalize on that market potential. But, again, to your question, I think while our eyes are always open, we'll always pick up the phone if there's an interesting opportunity externally. I think we feel good about what we can do with the resources that we have right now. Just a follow-up on some of those new market opportunities. In terms of the education market, how would you size that market in North America and globally? And what's your current market share? Not sure we have that answer for you today. I'm looking at Mike to see whether or not we're at a point where we feel comfortable sharing that. Don't have it. I think it's relatively big in the Americas. I know that doesn't help you. Globally, we also see quite a significant opportunity. We're not as penetrated globally as we are in the US, both on the higher ed side and on K-12. But we definitely see opportunities for growth there. I would just add to that, certainly in the US market, there's been quite a flurry of investment and continues to be in both K-12 and higher education. Some of that supported by federal stimulus funding. We think there's a lot of opportunity that'll continue. In other parts of the world, it's the case in some markets in which we compete that countries or national governments are driving a significant investment in their education infrastructure as part of their broader national plans to support economic growth and wellbeing over time. And in many cases, those school systems in those countries are really eager to adopt new pedagogy and new ways of thinking about education to support learning. And that really plays quite nicely with how Steelcase education and Smith System have approached the market. So there's different dynamics playing out in different parts of the world, but we think there's quite a bit of opportunity really globally. Is the competitive landscape in the education market different from the traditional corporate market? Like, is it more fragmented? Do you have more scale than others? Or is it kind of a similar type market dynamic where there's a handful of larger players and then maybe some smaller players below that? Yeah, I think it's similar, but I would say that it is a pretty fragmented market. And I would say that the significant players in education in different parts of the world vary. So I think that is one thing that we look to as we think about our opportunities is to leverage Steelcase scale and Steelcase capabilities that we have thanks to our traditional business to allow us to serve the education market in a really competitive way. In terms of the new opportunity creation, can you help quantify that? Like, where does that show up? It's not on backlog yet. So at what stage are these opportunities? And are you getting a sense of an acceleration in the timeline of decision making? Like, where is this leading us to, like, well, the next maybe couple quarters or next year? Like, are you kind of feeling that maybe businesses are ready to make a decision here or move forward? Or are they just still on the researching phase here? Well, I wish I had answers to all those questions, Greg. What I can tell you is that after several months of up and down across opportunity creation in the Americas, we've now seen six consecutive months that had pretty much – I'm looking at the chart now, pretty much double-digit increases, some of which were pretty strong over prior year. Now, some of that could be weakness in the prior year, but six consecutive months of it improving is quite positive. And what it is are coming from our CRM tool where our sales organization are entering opportunities that they're learning about, that they're competing to position Steelcase to win for. When we looked at it – Mike, I think you've looked at across – or the sales team in the Americas looked across regions, vertical markets, to see if there was anything kind of isolated or significant that stuck out. And it seems pretty broad based in the feedback that we got. So I can't help but take it as a positive. And I think it is a positive. But I don't know how quickly it'll materialize into a revenue generation. What I will tell you is there still are not large multi-million dollar deals in the same number that we had pre-pandemic. So there are some of them, but there aren't that many of them. So this tends to suggest that the opportunity creation is more mid-sized or smaller initiatives, which do have the potential to ship faster than larger projects. Lastly, in terms of the gross margin, we look back a couple of years, it was in the low 30s, 31% to 33% range. Do you think you could get it back there over time? Is there anything that's structurally changed to why you wouldn't be able to get back to that level of profitability? I think so. We will have to sustain our pricing benefits that we've put in to cover the inflation and earn a margin on that inflation. And we'll need volume to obviously recover, but I don't see any structural difference between the gross margins on the revenue that we're diversifying toward versus our core industry. So, we would expect to get back to or even potentially exceed the gross margins that we had. And like, FY 2020 is an example. I'm thinking about extended shipping times for backlogs, and backlogs still being at these elevated levels, how much of that is due to delayed shipments to you or from you? How much of that is customers pushing out delivery times after an order is placed? Just any color on larger backlogs and kind of where you see that trending over the next couple of quarters? I would guess that the majority of it is due to our customers pushing out dates. We hear a lot of noise around labor in construction sites. We certainly still are dealing with supply chain disruptions. We have late POs every week that are still significantly higher than what they were pre pandemic. But it's substantially less than it was 6, 9, 12 months ago. So I think we're probably contributing some, but I would guess the larger contributor is the site readiness, the time it's taking to get sites fully ready for furniture installation. In the other category with China reopening to a greater degree recently, are you seeing any orders ramping or conversations improving there from the prior months? That's a good question. We actually did have one relatively large order that did finally get ordered that certainly felt like it was on hold during the lockdowns. So, if that is an indication of a trend, then that would be great. But it was really only one order. But it was a relatively big one with one of our largest customers that our local teams tell us had paused because of the lockdowns in the region. Last one for me. Thinking about the consumer space, you've been attacking that over the past few years with a number of partnerships that seem to be doing well. Is this still over the next few years a partnership driven approach? What can you do to accelerate growth and profitability in that particular segment? And then lastly, is direct-to-consumer a model that is being pondered for you guys to go after it in a greater way? Well, I'll start by saying that we do have a direct-to-consumer business today through our Steelcase Online store. So that is part of our retail strategy and a portion of our strategy that we intend to continue. But as you point out, partnerships have also been critical to our strategy, knowing that we can bring the design, the engineering, the quality, the manufacturing, the insights-based innovation and combine that with some of our partners' consumer brand recognition and their reach into the consumer market. And we think that that combination is a really good one. And it's one that has been bearing fruit both here as well as in Europe. And we certainly think that there's potential to continue to grow through those partnership relationships. So I would say for the moment, our strategy has been both direct-to-consumer, but also a strong emphasis on partnership. And in the near term, I think we intend to continue kind of both those tracks. Can you share anything on profitability in that part of the business and maybe where you see it evolving in the next couple of years? Profitability is really strong in our kind of our broad consumer business. It's similar to the kind of margins and operating income that you see disclosed separately from some of our competitors. Two questions. One, you talked about the structural not seeing much difference in – I think it was the Americas you were referring to, Dave. Is there any structural difference you're seeing in EMEA or in other or the APAC areas that we should be noting? Additionally, you talked about and I made – and I'm old enough to remember some of the flash points when the airplane was sold and we had the excess CapEx to fund those for technology and safety reasons in the past. And yet, you're moving away from that which is understandable in today's environment, and laudable, frankly, but you have an enormous asset in Steelcase U. And so, how can you marry the asset you have in Steelcase University to really help customers understand what's going on with work and what's different with work? That's a great question. And I would say that, first of all, our intent is to certainly continue to leverage Grand Rapids as a significant customer location, just as it has been. We have hundreds of customers visit this location every year, who come here on their own, whether that's commercial aircraft or car or whatever it might be. So we don't intend that to change. And we do see that customer behavior has really changed in this respect, that customers, in many cases, are less willing to travel or less willing to travel significant distances. So we think it really is time not to – certainly not to lessen the importance of Grand Rapids, but really to amp up the importance of many of the other investments that we have, significant investments in other locations around the country and around the world. So, we really look at this as a strategy to be able to allow more people and more customers to experience the best of Steelcase, not just in Grand Rapids, but in all of the other locations where we also have significant investments. And we've really seen during the pandemic terrific traffic in many of those locations. Again, if people have chosen to stay closer to home or have looked to just to make different decisions about how they spend their day. So, we've been really buoyed by that significant traffic and I think there's something there to capitalize on. So, Grand Rapids will continue to be important. We continue to expect to have significant customer visits to this location. But we also need to make sure that we are providing the best of Steelcase to people in other locations as well. Sara, do we infer from that that there's going to be more showrooms or more mobile events of some sort to go around? I would say two things. One is that in existing showrooms and locations, we are continually evolving the experience and making sure that we can provide the right kinds of experiences and sort of high impact meaningful engagement with customers in those locations. So that could be using digital tools, that could be bringing in expertise, that could be thinking about how we continue to have our most up to date innovation available and there for customers to try out. So there's a whole host of things that that we intend to do in those locations. But you're right, we've also pursued a strategy of pop up spaces in cities where we don't have a permanent showroom. And that's been quite successful as well. So we also anticipate continuing to leverage pop up locations as part of our overall go-to-market approach. Last for me. I'm going to sneak one more in if I could. You mentioned and quantified a 20% to 25% hole. Just help me understand the dollar magnitude of that 20% to 25% hole that you're talking about? Because definitely the reporting over the last several years has changed so many times or given us different footings that I'm unable to get a number that may match the percentage? Well, first of all, I would just remind you that we're not projecting that. We're really just sharing it to give you a sense of – we're not imagining the industry might be only smaller by a few percentage points or that we don't have any scenarios that suggests it's going to be 50% smaller. So we were just trying to, rough, give you a sense of the magnitude of the kind of hole we think our existing strategies can fill. And, therefore, we use an approximation of 20% to 25%. Again, what we're talking about there is what the industry might look like two, three years from now once return to office and hybrid work has found its future state and settled in. We acknowledge there's probability that the industry could be smaller. And if it's smaller by that amount, we think we can fill that hole with our targets to gain share in a smaller industry through our ongoing investments in support of hybrid work, as well as our diversification strategies across the segments that Sara summarized. Understood. But I was trying to get to the number that, if that happens, what is that dollar number? What is that percentage of? And what does it get us to terms of dollars? Well, you could start by going back to FY 2020 and looking at the Americas and taking some hair cut for that to try to get to kind of the core traditional contract office furniture and then take 25% of it. So I don't know what the exact math is. But if you took 25% of FY 2020 Americas revenue and then took 25% of that, you'd probably be in the ballpark. But Mike could probably help you with some offline math from different disclosures that we've had over the last few years. In one sentence, it was industry and then it was Americas, and so I'm just trying to – from apples to oranges. But we'll take it offline. Great. Well, I would just thank all of you for joining us this morning. And we wish you all a happy holiday and appreciate your interest in Steelcase as we navigate through these challenging times and focus on driving improved results. And hope you have a great day.
EarningCall_1478
Hello, and welcome to The Greenbrier Companies First Quarter of Fiscal 2023 Earnings Conference Call. Following today's presentation, we will conduct a question-and-answer session. Each analyst should limit themselves to only two questions. Until that time, all lines will be in a listen-only mode. At the request of The Greenbrier Companies, this conference call is being recorded for instant replay purposes. At this time, I would like to turn the conference over to Mr. Justin Roberts, Vice President, and Treasurer. Mr. Roberts, you may begin. Thank you, MJ. Good morning, everyone, and welcome to our first quarter of fiscal 2023 conference call. Today, I'm joined by Lorie Tekorius, Greenbrier's CEO and President; Brian Comstock, Executive Vice President and Chief Commercial and Leasing Officer; and Adrian Downes, Senior Vice President, and CFO. Following our update on Greenbrier's performance in Q1 and our outlook for the rest of the fiscal year, we will open up the call for questions. In addition to the press release issued this morning, additional financial information and key metrics can be found in a slide presentation posted today on the IR section of our website. I'd like to remind you that matters discussed on today's conference call include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Throughout our discussion today, we will describe some of the important factors that could cause Greenbrier's actual results in 2023 and beyond to differ materially from those expressed in any forward-looking statements made by or on behalf of Greenbrier. Thank you, Justin, and good morning, everyone. I hope everyone had a good holiday season. Our first quarter results showed areas of continued strength and identifiable opportunities to improve our operations. We produced 6,800 units in the quarter, a 10% sequential increase. Of these 2,300 units are investments held on our balance sheet to be syndicated our capitalized into Greenbrier's long-term lease fleet in a future period. Remaining customer deliveries totaled 4,800 units. Revenue was in line with expectations. However, the efficiencies expected from higher production levels have not yet been fully realized. Aggregate gross margin was impacted by higher cost of outsourced components driven by inflation, transportation expense, and other logistics challenges. Material shortages and delays and other lingering supply chain issues including rail congestion in Mexico, created production disruptions primarily at our manufacturing operations in Mexico. We remain focused on managing our cost and supply chain. We're optimizing our internal fabrication capacity, which will improve profitability by having more control over vital supply chain and address supply chain inefficiencies. Additionally, as disclosed in our earnings release, we will seize new railcar production at our Portland, Oregon facility in May following the delivery of existing commitments. This is not a decision we've taken lightly, given our history of manufacturing railcars in Portland. However, it's an action that reflects our commitment to optimize the efficiency of our manufacturing footprint and deliver stronger margin. We're undertaking a strategic evaluation of our marine business, which operates at the same facility. We're currently engaged in a range of discussions to determine both the future of marine operations and the overall use of the Portland facility. I remain confident we'll attain a good outcome for all of our stakeholders, which include employees, customers, and shareholders. Our Maintenance Services Group continued their positive momentum and started 2023 with a strongest Q1 performance in five years as initiatives focused on increasing efficiency translated to results. Our Wheel business unfortunately was negatively impacted by increased labor and transportation costs. We're currently working with our customers to modify contracts to address the current cost environment. Turning to the U.S. economy, while it continues to its resilience rising interest rates and inflation now weigh on growth. The labor market has remained strong, and we're cautiously optimistic about the industrial sector of consumer spending soften. The economy appears to be normalizing after years of unprecedented demand caused by lockdowns and subsequent government stimulus. As a result, economic activity will slow with an estimated annual U.S. GDP growth rate of only 0.2% in 2023. The lower outlook projects an economic soft landing that will be characterized by a strong labor market, but with elevated inflation and interest rates throughout the year. Consumer spending, which makes up two-thirds of economic activity, will likely determine the timing and depth of the slowdown. We continue to believe the North American rail freight segment will be resilient through a mild recession. Rail labor negotiations in the latter months of calendar 2022 drew broad public awareness to the integral role the rail industry plays in our economy. The near term threat of a railroad workers strike ended on December 2 with President Biden signing preventative legislation. However, challenging railroad service conditions now follow us into this new year. We're optimistic the railroads will make steady progress on their service models over the course of the year and increased hiring is an early positive step in this direction. Turning to our European business. Despite an energy crisis caused by the Ukrainian war, high inflation and the rising interest rates, the European economy appears to be holding up well. Energy prices are down from their peaks due to a mild winter and gas storage facilities at full capacity. German industrial output grew in the last quarter, surprising most analysts. And rail traffic levels in Europe are high and fleet utilization is nearly 100% for most wagon types. The one exception is international container traffic where volumes are down due to the sluggish Chinese economy, which continues to struggle with COVID. Our European business performed well despite the war and lingering effects of the pandemic. And now turning to some other milestones in Q1. On November 1, we released the fourth annual edition of our ESG report On Track Together. I'm pleased to report, the Group have been identified on the list of the most responsible companies in America, according to Newsweek and the global research and data firm, Statista. The third-party recognition validates Greenbrier's commitment to our values and our pursuit of responsible corporate citizenship. On a company level, we continue to review and optimize our portfolio to create a stronger, more sustainable Greenbrier. As announced earlier this week, we've acquired the minority interest in GBX leasing from the Longwood Group. This action bolsters Greenbrier's leasing platform, simplifies our business structure and promises long-term value to our shareholders. Growing our leasing business provides us a broader, more holistic view of the railcar equipment market than not solely an OEM builder. It also discourages the prospect of overbuilding since an asset can be on our books for over 30 years. Despite the short-term operating challenges, momentum is good entering calendar 2023. With strong railcar order activity and elevated lease rates, we're confident in Greenbrier's long-term strategy and our team's execution. On our last quarterly call, we mentioned we discussed the strategy further at our upcoming Investor Day. We're currently planning to hold that event in April and look forward to sharing additional details soon. Thanks, Lorie, and good morning, everyone. In Q1, Greenbrier secured new railcar orders of 5,600 units worth $700 million, a 17% increase from Q4. These orders extend production into calendar 2024. We delivered 4,800 units in the quarter, resulting in a book-to-bill ratio of 1.2 times. As of November 30, Greenbrier's global backlog was 28,300 units valued at $3.4 billion, an indication of the strength of our customer relationships, and demand for Greenbrier's products and services. As a reminder, our new railcar backlog does not include 1,800 units valued at $150 million that are part of Greenbrier's railcar conversion programs. We continue to see healthy railcar inquiries and orders for a variety of railcar types despite a slowing economy. As we pursue commercial and leasing transactions, we are employing pricing discipline that considers current market dynamics and the state of the economy. Railcars and storage are at a cyclical low due to demand spikes, rail freight service challenges and retirements outpacing new railcar deliveries. From January to November of 2022, there have been approximately 50,000 railcars scrapped. This is more than delivered in all of calendar 2022. Type railcar supply provides tailwinds for new orders in a range of railcar types. Earlier this week, we announced the buyout of the minority stake in GBX Leasing, our railcar leasing joint venture. Full ownership of the fleet furthers our leasing strategy while simplifying our business structure. We are pleased with the performance of leasing and management services in the quarter. Our lease rates on renewal are increasing by double-digits, and we are extending lease terms while maintaining a high fleet utilization of 98%. Our lease fleet grew to 14,100 units at the end of the quarter. Keep in mind that a number of the units added to our lease fleet in the quarter could be syndicated over the course of the fiscal year. We intend to grow our long-term lease fleet by approximately 2,000 units this fiscal year. Fleet growth for the year is focused on railcar types that will further diversify the fleet, reducing concentration risk. We funded another $40 million of leasing term debt during the quarter and will fund the final $35 million in Q2. Additionally, we have not borrowed on the $350 million leased railcar warehouse facility, although we are evaluating financing strategy for the remaining of our lease fleet adds for fiscal '23. Our capital markets team syndicated 300 railcars in the quarter, a decrease from last quarter due to the timing of production activity. We continue to successfully navigate the compound challenges of higher debt costs and higher railcar pricing. However, we do see sufficient investor liquidity in the market for the duration of fiscal 2023. With one fiscal quarter in the books, we enter calendar 2023 energized and excited by the opportunities in front of us to grow our leasing business and successfully execute our market-leading syndication strategy. All of this supports our ultimate goal to provide our customers maximum flexibility to access Greenbrier's superior products and services. Thank you, Brian, and good morning, everyone. Before moving into the highlights of the quarter, I would like to remind everyone that quarterly financial information is available in the press release and supplemental slides, which can be found on our website. Our performance in Q1 was mixed with strong commercial, leasing and maintenance services performance, offset by headwinds in the manufacturing business, particularly in North America. A few items I want to speak to for the first quarter included revenue of $767 million, which decreased sequentially primarily from the production of 2,300 leased railcars on to the balance sheet. As a reminder, we do not recognize manufacturing revenue or margin until the railcar leaves our balance sheet. However, we do recognize lease income for railcars on our balance sheet. This activity is more of a timing variance since these railcars will either be syndicated or capitalized into our long-term leased late later in the year. Deliveries of 4,800 units include 300 units from our unconsolidated joint venture in Brazil. Aggregate gross margins of 9.1% reflect higher costs for outsourced components, material shortages and lingering supply chain issues, including rail congestion in Mexico. We are investing in internal fabrication capacity to improve our control over this aspect of our supply chain while the rail congestion continues to slowly improve. Selling and administrative expense of $53 million is 22% lower from Q4, primarily as a result of lower employee related costs, including incentive compensation and consulting expense. The pretax impairment charge of $24.2 million was related to long-lived assets at our Portland and Oregon manufacturing facility. This was triggered by the decision to end new railcar production at the facility after an evaluation of our production capacity requirements. Excluding the impact of this impairment, adjusted net earnings attributable to Greenbrier of $1.6 million generated adjusted EPS of $0.05 per share. Adjusted EBITDA was $48.7 million or 6.4% of revenue. Greenbrier's liquidity was $477 million at the end of Q1, consisting of cash of $263 million and available borrowings of $214 million. Our liquidity remains ample, the primary use of our cash during the recent quarter included a continuing investment into our lease fleets and the expenditure of working capital related to the manufacturing supply chain issues we have already mentioned. As a result of the strength and flexibility of our balance sheet, we continue to be well positioned to navigate these market dynamics. During fiscal 2023, we expect liquidity levels to increase from improvements in operating results and working capital efficiencies as well as increased borrowing capacity resulting from more railcars placed on our balance sheet. As a result, the remaining tax -- as a reminder, the remaining tax refund associated with the CARES Act of roughly $30 million is anticipated to be collected this fiscal year and will be additive to Greenbrier's available cash and borrowing capacity. Greenbrier has $100 million authorized under our share repurchase program, which was just extended by our Board of Directors through January 2025. Our Board and management team remain committed to a balanced deployment of capital designed to create long-term shareholder value. We will continue to use this capacity opportunistically based on fluctuations in the price of Greenbrier shares and within the framework of our broader capital allocation plan. Subsequent to the end of the quarter, we have repurchased nearly 100,000 shares. Finally, on January 5, Greenbrier's Board of Directors declared a dividend of $0.27 per share, our 35th consecutive dividend. Since reinstating the dividend in 2014, Greenbrier has returned over $400 million of capital to shareholders through dividends and share repurchases. Based on yesterday's closing price, our annual dividend represents a dividend yield of approximately 3.1%. Turning to our guidance and business outlook. Based on current trends and production schedules, we are maintaining Greenbrier's fiscal 2023 guidance, which includes deliveries of 22,000 to 24,000 units, including approximately 1,000 units from Greenbrier-Maxion in Brazil. Revenue between $3.2 billion and $3.6 billion. Selling and administrative expenses of approximately $220 million to $230 million. Gross capital expenditures of approximately $240 million in leasing and management services, $80 million in manufacturing and $10 million in maintenance services. Proceeds of equipment sales are expected to be approximately $110 million. Our now wholly-owned lease, lease will increase by at least 2,000 units in fiscal 2023. We will see how the leasing market evolves throughout the year, and we'll be flexible and opportunistic in our growth strategy for the fleet. Gross margins, we expect full year consolidated margins will be in the low double-digits. Our bottom line results in Q1 do not fully characterize the improvements and positive momentum occurring in our business. We expect our performance to improve in the coming quarters as we hit our stride, and we see the benefits of tough decisions taken in Q1. Our management team is experienced with a demonstrated track record of success. Our robust backlog provides strong visibility and stability over the coming years, and we look forward to improved results as we progress through the year. Thank you. We will now begin the question-and-answer session. [Operator Instructions] Today's first question comes from Justin Long with Stephens. Please go ahead. I wanted to start with a question on the supply chain. Just given the trends there seem to be a little bit disappointing relative to expectations. Any updated thoughts on the supply chain recovery going forward? And for the ceasing of railcar manufacturing operations at Portland and the increased capacity internally as it relates to fabrication. Is there any way to put a number around the cost impact that could have going forward? Starting with the supply chain, I think as we have ramped up our activities as well as other industrial manufacturers that has put more pressure on the supply chain that we rely on, particularly in Mexico, which we recognized and have taken the action to start in-sourcing initially the vital components that we need for building railcars and making certain that we are achieving the kind of cost that we need to. So we're not happy with what happened in the first quarter, but we are taking action and we expect that new fabrication facility to be online early in our fourth fiscal quarter. So things are changing and moving. I think as we talked about it, we would expect this to be probably a couple of hundred basis points of margin impact as we move through the fiscal year associated with supply chain. With the Portland, Oregon facility, not sure that we would quantify a facility-by-facility financial results. You do see the asset impairment that we took that's associated with the railcar piece of our business, evaluating the assets that are dedicated to railcar production and adjusting those to an appraised value and we are still in the process of evaluating our Marine business to determine what comes of that. And then the last question, no, I don't remember. We're not going to be using the Gunderson facility for any of the sub-components. This is in-sourcing that will happen near our facilities in Mexico. Got it. I think you tackled everything. And just to clarify one point, when you mentioned a couple of hundred basis points of improvement in gross margins from the supply chain. Is that manufacturing gross margins? And is that just solely related to the supply chain getting better or is that incorporating what you're doing on the fabrication side? So Justin, that is on manufacturing, and that is solely related to what we're doing on the internal fabrication piece. The improvement or, I guess, I would say, lack of disruption on the supply chain going forward is a little harder to quantify, but I would say that, that's a similar, if not maybe even larger number ultimately. Okay. That's helpful. And then last thing I wanted to ask about was just the railcar order environment. Could you break down orders in the quarter between North America and international? And maybe, Brian, you could chime in on the sustainability of this kind of 5,000 to 6,000 orders per quarter flow going forward? Yeah, Justin, it's Brian. About 95% of the orders in the Q were for North America. So substantially in North America, we're already -- December was a stronger month than what we typically see because of the holidays. So we're already off to a good start. I would say the cadence continues to be very similar to what we've seen in the last three, four quarters in North America. We're not seeing any falloff at all at this stage. Great. Good morning. Maybe you could talk a little bit about the manufacturing margins. Typically, we see a falloff in second quarter. I don't know if given the closing of Portland, it sounds like that doesn't occur until May or some of the other moves you're making -- are there going to be increased costs given the fabrication moves as well as still getting the supply chain online until that's up and running in the fourth quarter? So do we see and even extended dip in 2Q on margins. Maybe just walk us through, Adrian, your thoughts or Lorie, on kind of seasonality and impact from the moves you're making? And I'll start, and then Adrian or Justin can chime in. But it’s a good point, Ken, that yes, seasonally, second -- our second fiscal quarter, which includes a lot of holidays does sometimes have an impact on our margins. So there's -- it's probably a mixed bag as you think about how we step through the year. We're not going to get into quarter-by-quarter margin expectations. We do expect there to be, though, an overall improvement as we move across each of the quarters of this fiscal year. Regarding rail production at Gunderson, we had a full quarter of production in the first quarter at our Portland facility, and that will continue through May. So we will have those three quarters, which I would say is, it's neutral to a bit of a drag on margins, but that's where I would say that kind of shakes out. And any additional costs that are associated with ceasing those productions or the transition of our workforce, we will make certain to capture those separately and communicate them separately. And Ken also the investment in bringing the fabrication in-house is something that will be capitalized, that would be something that will provide long-term benefits. So you wouldn't see necessarily a higher operating expense from that, you would see overall market -- margin improvement. And finally, Ken, one other piece on to that as we progress through the year, we will see the increased syndication activity, which is typically beneficial to overall company margins throughout the year. Great. Thanks for that everybody. And then I guess, in the past, you've given kind of the balance of production and what you expect, maybe it sounded like Lorie, you threw out at the end of your last answer that there was no slowdown in the orders. Maybe talk about how back-end loaded production will be and the move, I guess, away from Portland to Mexico. Is that -- obviously, we had a huge surprise on cost this quarter given all the things you mentioned. Is that just determination that it's just too costly in the U.S. and moving everything to Mexico? And does that mean anything for the U.S. assets from ARI that you acquired in the U.S. or was this Portland specific? So this was Portland specific. We are not intending to relocate all of our manufacturing to Mexico. There's definitely a lot of benefits and value of having a U.S. manufacturing footprint. The facilities that we acquired was announced in 2019. They continue to perform well. And as you think through deliveries and the impact from ceasing the production at the Portland facility, they're running at a very, very modest pace. So I would say it's not something you're going to really notice as -- and looking at the quarterly delivery activity, particularly as in this first quarter, we had a larger number of units that we capital -- are not capitalized, but are held as investments on our balance sheet, which will be syndicated in future periods, which will then become deliveries, right. So that will offset the wrapping up of rail production at Gunderson. Hi. Good morning. Lorie, [Multiple Speakers] back to your last point, those cars on balance sheet. I know that you guys mentioned the syndication obviously be beneficial. But is there a way to estimate or how you're thinking about what you're going to hold on in your only weeks I imagine that impacts the margin -- or the profitability as we're thinking through the year? Just any thoughts there. Well, I'll get Brian to talk to that because he's working really closely as we evaluate kind of which pieces of equipment we hold on to and which we syndicate. Yeah, Allison, what we're -- our stated goal, just to maybe restate it is to hold about 2,000 cars a year on our balance sheet. I think in Q1, we originated about that many a little bit more. What we're doing now is we're going through the process of identifying which ones we want from a concentration and return perspective, and then we'll begin to move some of those into the syndication channel. So Q1 was heavy in lease product. That's one of the impacts, but that will start to get released throughout the year and our plan from a leasing perspective is, again, to keep about 2,000 cars throughout the year. And just from a production perspective, there are -- we will be producing cars onto the balance sheet and then moving cars off the balance sheet through syndication throughout the year. This wasn't a one-time thing. It's just more a matter of it was more heavily weighted in this one quarter. Yeah. I guess I was just -- because I think it doesn't -- maybe we can talk about this offline, Justin. The impact of the cars that you're putting in your own fleet, you don't necessarily recognize the profit. So I was just thinking if there was an impact we should be thinking through as you determine what you're keeping and what you're syndicating out. You are exactly correct, Allison. We do eliminate that revenue and margin from the manufacturing business when they are on the balance sheet and when they go into the long-term fleet, then it's just a matter of recognizing the lease income over the period of the lease. So again, we can clean up any details offline, but yeah, you are right about that. And I would say, this is something that is unknown, right? As we are building equipment that we will capitalize on our balance sheet and hold long term. We absolutely acknowledge that we are foregoing the profit in the moment, but believe that having that repeatable revenue, cash flow, tax advantaged cash flow is good as a balance to our strong manufacturing operation. Certainly. And then I know, Lorie, you mentioned revenue was in line with your expectations, but it sounds like production did slip a little bit to the right because of the supply chain. Is there any way to quantify what that number was in terms of production level that you guys had that kind of maybe get pushed to the right and is probably more back half weighted here, just any thoughts? Sorry, you asked Lorie, but I was going to say a few like kind of $300 million to $500 million is probably slipped from the quarter from that perspective. The piece that was a little more punitive though, was the disruption and the inability to maintain consistency of production on certain lines throughout the quarter. Thanks for taking my questions. A lot of questions on margin, given the surprise. But Lorie, you opened your comments with a look at the macro and I talk about some of the softening indicators from a top down perspective. Is that a message that we think we're kind of getting to the top of the cycle or more of the plateau type environment that you've talked about with maybe not as higher highs and lower lows of the railcar cycle, as we've known for much of the last 20 years? Can you just unpack the message here from a macro perspective and kind of your strategic views as you look out beyond a quarter or two, maybe two, three years and how you're playing the business? Thank you. Well, happy to know your, Bascome. Yeah, I think at least everything that we are seeing both internally and from looking at external forecasters, it certainly appears that we're going to be in more of a plateau when it comes to new railcar production. While that might disappoint some who like roller coasters, we're kind of excited that we didn't actually have the huge run-up that some other sectors did. So therefore, I don't believe we're going to have quite that accelerated downfall either. It will be more modest I think there is a lot of pent-up demand when it comes to rail freight movements. A lot of shippers have had to move their product in different ways. The railroads continue to embargo and not provide the kind of service that their customers need. So as they're able to add workforce, those of us who support the railroads and the rail freight industry, believe that, that -- those loadings are going to go up, the performance is going to improve and that will make for good demand. The thing that's difficult is, is there a particular movement or car type change that can sometimes create those spikes in demand that you -- is more behind some of those run-ups. Again, we don't -- I don't see that in my crystal ball right now. And I think that having the steady and diversified activity that we're seeing on manufacturing is good both for us, for a manufacturing -- well, maybe it's a little bit more difficult for our colleagues in manufacturing because it's a lot easier to just build one or two car types as opposed to eight different car types, but it does provide us a lot of benefits in the lease fleet that we're building to make certain that we've got good diversity, good quality customers, and it's good for our operating lessor customers and our syndication partners who are also looking for diversity in the equipment that they buy from us. Thank you for that. Can you talk a little bit about cash flow? Maybe this is one for Adrian. I know it's a little bit different now that you're investing more and more in the way that you account for your lease fleet. But do you have some thoughts on operating cash flow maybe before that lease (ph) investment -- lease sorry, lease investment this year? And if there will be a working capital releases get through some of these supply chain disruptions that have been sporadic but in material multiple times in the last few quarters? Thank you. Yeah. We would expect cash flow to be positive for the balance of the year on an overall basis. So a few of the major drivers, syndication activity should generate cash. And you can see we invested in putting a lot on our balance sheet in Q1. That cadence would be different to rest of the year. We would have improved operating results that will also help. And as you mentioned, we would expect to see some working capital efficiencies as we navigate these issues that we had in Q1, which are more short term. We have invested a lot compared to historical periods in working capital as we ramped up and we should start to see some efficiencies just from normal course as well as from resolving some of these sporadic issues that impacted Q1. Good morning. Thank you and sorry if my question has been asked as I had some connection issues on my end here. I want to go back to Gunderson. Lorie and Justin and the team, how much of the decision to close the facility has to do with maybe chronic access to labor issues even before COVID? And if that was one of the considerations, can you talk about your access to labor in the Northwest versus in other parts of the country in the Midwest and the South. Sure, Matt. Thank you for that. I don't think that we are unique in talking about having workforce attraction and retention issues. The Northwest is a little bit different as well. It's not a heavy industrial area. So it's a tough area to attract and retain a workforce. I will say that we do have a very solid and dedicated workforce that many of which have been with us for a very long time. So as I said in my prepared remarks, this was not a decision that we took lightly. We know that Gunderson is something that we've had for all of our existence, right? So this is tough. Our facilities in Arkansas, again, similar to other businesses struggle to attract and retain folks within a very difficult working environment. And so we're thinking about how we make adjustments to where we source folks, how we pay, what our conditions are thinking through the hours in a day that someone works or the fact that more people today want to work part time as opposed to -- sorry, that was -- I'm sure that came through in my voice. I'm old, and it's confusing for me that people have a hard time working a full day. But -- so we're looking at all the different things that we can do, the levers that we can pull to attract and retain a workforce that I think are great family wage jobs. Now I've got some worked up over workforce. I forgot what the rest of your question was. I just was hoping to get some comparison between access to labor between the different regions. I mean, I think you answered that the Northwest may be a bit more challenging, I guess, than the rest of the country. But I also want to kind of ask you about what’s your -- I know it's difficult to say -- to put a number of capacity -- annual capacity numbers because the cycles differ and the types of equipment produced affects that number. But after the closure of Gunderson, how much annual capacity would you say you would have in the U.S.? I don't -- I think as we've talked about our capacity numbers, and I don't -- Jeff will have to correct me if I'm wrong, but I don't think that as we've thrown out what I would a theoretic capacity for the North American market, we've probably not been for the last several years, assuming large numbers when it comes to the Portland facility just because we have been operating at a more modest rate. There was one other thing that I thought about in your -- the earlier part of your question and thinking about our decision for ceasing railcar production in Portland. Part of it is also where our customers are and where our competition is. And as we need to be able to be competitive in the broader market, cost-wise for our customers, there has been kind of this transition to the middle part of the country and south which is also very good from a logistics and transportation perspective to get our equipment to the customers that want to use it. So that also weighed into the decision that a location in the Pacific Northwest does have some difficulties as you've seen more and more freight moving to East Coast ports and the like. Yeah. Makes sense. And then I know most industries are having supply chain issues, but it seems a bit more pronounced in the case of the railcar industry, Lorie. Do you -- I mean, first of all, is that the case? And second, why is that? I mean we've heard that maybe because of a more limited pool of suppliers on the component side. But are there any other factors that are specific to the railcar industry that are making the supply chain issues subside at a slower rate than maybe some other industrial areas? It is a little bit head scratching. I would say that it's likely because we and some of the others in the rail space have been ramping up production. So we are putting some pressure on that supply chain that they didn't have over the last two years. I think, quite honestly, in the rail freight OEM space, we've been -- overall, I'm sure that my procurement folks are going to kick me after this. But I would say compared to the rest of the country, we haven't had the big disruptions. So I think it's as we and others in the industrial space ramped up over the last four to six months. It's really putting that pressure on that supply chain to be able to be responsive. Got it. And then just one final question on margins. This is taking a long-term view. All the changes that you're making, Gunderson and then the leasing. Does it change your outlook -- long-term outlook for what kind of gross margin you can get? I think these are all steps that we need to take on the journey to having solid double-digit low -- in the teens, margins on a regular basis is to look through our organization and determine where we can strain more efficiencies and costs for the business to generate that sort of return. So from my perspective, I and the leadership team, we look across the organization, and we're identifying the areas where we can start to take some action, and we're taking that action. Some of it is going to take a little bit of time. But we'll do our best to be transparent with you and our shareholders about how we're -- what -- the steps that we're taking, but it's all towards that longer-term goal of having those steady margins. And I would say, truly higher highs and higher lows. So having the lease fleet will help, I believe, to take some of the trough out of the low cycles when it comes to railcar manufacturing. Potentially, we have a couple of years here of some steady demand on that side of the business, which will allow us to really look through the operations and see where we can continue to optimize them. Appreciate the detail on some of the actions you're taking in the near term. On the last call, you suggested earnings would have maybe a 40% first half, 60% second half weighting. As you think about it now, should we be thinking that's more 25-75, or what do you expect for an earnings cadence for the year? Okay. And Lorie, you've had to deal with some tough operational conditions for a while. You're obviously taking actions to address that. For 2023, what is -- can you just talk about your priority list? Is it really fixing gross margin first? Is it driving syndication activity or market share? And then second part to that question, maybe you answered this to some degree. But longer term, what do you see as the key to driving shareholder value creation? What's that message that you're pushing to the team? We're trying to steal our thunder from April, Steve. You all make secrets right now. I think -- I would say, yes, my number one focus is improving our gross margins getting to that steady margin that I know that we can do. And then we will look to how we're optimizing the services side of our business, which -- the biggest piece of that is leasing and figuring out how we do that at a modest pace, balancing it with our customer needs for -- on the syndication side and the operating lessor side, this is something that Greenbrier has done for years. We have been able to manage relationships with a wide variety of customers and do this in a way that I think can be beneficial for our shareholders as well as for our customers. So it's not going to be a revolution. It's going to be an evolution of how we're going to continue to build off of the foundation. Looking at some of the investments that we've made over time are where we have value tied up on the balance sheet and how we can either get that -- those investments on our balance sheet to generate better returns or to offload them and focus on the things that are our priorities. Got it. Thanks. And I'm sure you'll talk more in April about all that. In terms -- for the near term on the gross margin, what is the biggest bucket of value creation or margin expansion? Is it optimizing the manufacturing or the internal fabrication capacity? Is it just footprint? How much does mix play into that? Like what levers are you pulling first to drive that near-term outcome? I think definitely, it is the supply chain and in-sourcing some of those vital components that we need to make certain that we are managing those costs. Bill Krueger, who is now running our manufacturing operation has been working closely with the teams on the ground to really think through if we have certain capacity within our operations, are we utilizing our capacity to its highest potential and for the most vital components? And really thinking through that a lot more strategically, particularly as we're building a broader range of products that requires a broader ability to provide those subcomponents. Do you think you have the manufacturing capacity, the process equipment that you need or would this require investment in machinery to be able to in-source some of that? This concludes our question-and-answer session. I would like to turn the conference back over to Justin Roberts for any closing remarks. Thank you very much for your time and attention today. If you have any follow-up questions, please reach out to us at investorrelations@gbrx.com. Have a great day. Thank you.
EarningCall_1479
Good morning, and welcome to the Third Quarter 2022 Bed Bath & Beyond, Inc. Earnings Conference Call. My name is Cheryl, and I will be your operator for today's call. [Operator Instructions] Please note that this conference call is being recorded. Thank you, and good morning, everyone. Welcome to our fiscal 2022 third quarter earnings call. On today’s call, you will be hearing from Sue Gove, President and Chief Executive Officer. Before we begin, I’d like to remind you that our fiscal 2022 third quarter earnings release can be found on the Investor Relations section of our website at bedbathandbeyond.com and as exhibits to our related Form 8-K. This conference call and the press release we refer to may contain forward-looking statements, including statements about or references to our outlook regarding the company’s performance, our internal models and our long-term objectives. All such statements are subject to risks and uncertainties that could cause actual results to differ materially from what we say during the call today. Please refer to our most recent periodic SEC filings for more detail on these risks and uncertainties, including the Risk Factors section in our annual report on Form 10-K and our quarterly reports on Form 10-Q. The company undertakes no obligation to update or revise any forward-looking statements. Additionally, the information we will discuss today contains certain financial measures that exclude amounts or are subject to adjustments that have the effect of excluding amounts that are included in the most directly comparable measure prepared in accordance with generally accepted accounting principles. For a reconciliation to those comparable measures presented in accordance with GAAP, please refer to the table in our earnings release available on our website and included as an exhibit to our Form 8-K filed today. Lastly, in light of the ongoing review of strategic alternatives that we disclosed last week, we will limit today’s call to our prepared remarks. Of course, as always, please feel free to reach out to me with any questions. Thanks, Susie, and good morning, everyone. In light of our preannouncement last week, we recognized the importance and focus on today’s call for those who have been with us on our journey to enact significant change in our business over the past few months, especially, our customers, our associates and our business partners. While we reported our fiscal third quarter financial results in a press release earlier today, my remarks will be focused on the strategic pillars of our turnaround and the progress we are making towards our vision for the company. For decades, Bed Bath & Beyond has set the pace across the home goods sector, and we have commanded our position in retail through many different economic cycles and serving a continuously evolving customer. We believe our concrete advantages in defining categories, offering broad and curated selection and delivering great service for customers are compelling reasons why we will continue to command a formidable presence in the Home and Baby categories in the future. We have the talent and team to accomplish our goals. Our business was built around our loyal customers. Listening and responding to their preferences was at the center. Veering away from that path has led to our recent financial performance. We have taken aggressive action to change the elements of our business that are not aligned to what our customer wants. We are rebuilding our assortment to serve our customers’ needs by leading with national brands and reducing our owned brands merchandise at the Bed Bath banner. We are accomplishing these goals successfully as owned brand inventory penetration has declined 10 percentage points versus peak levels during the first half of the fiscal year. Furthermore, our closing store and no go-forward inventory has reduced from almost $500 million at cost on hand and on order to just over $130 million at cost in the last 6 months. We’ve achieved these results by purposefully utilizing our closing stores as targeted vehicles for clearance, as many of you have seen. These locations are signs of progress and effective execution. We are taking intentional action across our chain by allocating resources to achieve our strategic goals on a store-by-store basis. Despite this progress on owned brands, rebuilding our national brand presence will take time. Following some of the micro and macroeconomic challenges, we, and the sector faced, at the beginning of the quarter, we experienced an acceleration in vendor payment terms and credit line constraints. This led to lower receipts and, therefore, lower in-stock levels, in the 70% range, which hampered our sales further in an already competitive environment. We have worked diligently with our supplier partners and our payables remain at healthy levels, as demonstrated by the continued sequential decline in accounts payable as well as accrued expenses and other current liabilities on our balance sheet. We have already leveraged the liquidity gain from the holiday season to pursue more inventory and higher in-stock levels with support from our key vendors. Additional efforts are also underway to further increase stock levels. We’ve seen significant sales trend improvements on both the sequential and year-over-year basis where in-stock levels have improved to a more normalized range, above 80%, particularly related to our Bed Bath circular items and at our buybuy BABY business. This underscores our ability to achieve results when we have the supply. Our customers are still coming to us for their needs. In addition to our merchandise strategy, strengthening our operations and financial performance to better serve our customers continues to drive our decision-making. As part of our turnaround, we are resetting foundational elements to create a stronger and more nimble infrastructure that aligns closely with customer demand and preference. We are delivering on our aggressive second half commitment of $250 million in SG&A optimization, or $500 million annualized, and the 150 store rationalization target that we previously outlined. To more accurately align resources with our focus areas and future, we are enacting an additional $80 million to $100 million in cost reductions across corporate, including expense and headcount. Our organization is more streamlined to enable our priorities across Bed Bath; buybuy BABY; and Harmon, and we have adopted an infrastructure that reflects our current business priorities. We also recognize and embrace that our customer shops differently today. They visit stores less frequently and have higher expectations when they do visit around service, engagement and assortment. They want an omni experience that we are committed to deliver. Ease of shopping is critical, and we are committed to delivering such services as BOPIS and same-day shipping. At the same time, we are listening to our customers, and we are swiftly enacting improvements to their experience. The preliminary results of our supply chain network optimization Indicate the ability to improve our cost to serve as well as our time to deliver for our customers while driving an additional $80 million to $100 million in efficiency. We are implementing our plan expeditiously while managing our financial position in a changing landscape. As we shared last week, we continue to work with advisers as we consider all strategic alternatives to accomplish our near- and long-term goals. Internally and externally, we have a team with proven experience, helping companies successfully navigate difficult situations and become stronger. Multiple paths are being explored, and we are determining our next steps, thoroughly, and in a timely manner. We are committed to updating all stakeholders of our plans as they develop and finalize, particularly for our employees and partners, who are the essential catalysts of our business and the cornerstone of our future. Finally, we want our customers to know that we hear them and we are charging ahead every day to meet their needs. Our entire organization is laser-focused on maximizing the value of our company by reconnecting with our customers and positioning Bed Bath & Beyond, buybuy BABY and Harmon for long-term success.
EarningCall_1480
Good evening, ladies and gentlemen, and welcome to the Neptune Wellness Solutions Inc. Second Quarter 2023 Earnings Call. At this time all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. [Operator Instructions]. This call is being recorded on Friday, December 16, 2022. Thank you, operator, and hello, everyone. Thank you for joining us today for the Neptune Wellness Solutions fiscal second quarter 2023 earnings conference call. With me today are Michael Cammarata, President and Chief Executive Officer; and Raymond Silcock, Chief Financial Officer. All amounts discussed today are in U.S. dollars, and our remarks may contain forward-looking information representing our expectations as of today and may be subject to change. Today's conference call contains non-GAAP measures, specifically adjusted EBITDA to provide investors with supplemental measure of our ongoing performance and thus highlight trends in our core business that may not otherwise be apparent when relying solely on GAAP financial measures. Management also uses adjusted EBITDA in order to facilitate operating performance comparisons from period to period, prepare annual operating budgets and assess our ability to meet our capital expenditure and working capital requirements. Adjusted EBITDA is not a recognized, defined or standardized measure under GAAP. Our definition of adjusted EBITDA will likely differ from that used by other companies, including our peers, and therefore, comparably may be limited. Non-GAAP measures should not be considered a substitute or in isolation for measures prepared in accordance with GAAP. Investors are encouraged to review our financial statements and disclosures and in their entirety and are cautioned not to put undue reliance on non-GAAP measures and view them in conjunction with the most comparable GAAP financial measures. We do not undertake any obligation to update any forward-looking statement except as may be required by Canadian U.S. securities laws. Assumptions were made in preparing these forward-looking statements, which are subject to risks as laid out in our public filings found on SEDAR and EDGAR. Today, we reported our fiscal second quarter 2023 results for the period ended September 30, 2022. During our fiscal second quarter of 2023, we experienced continued growth, mainly driven by our organic baby and toddler food brand, Sprout. These results demonstrate that our strategy to focus on consumer packaged goods is yielding financial benefit and we are confident that this trend will continue. Because of our hard work over the last few years, we are now a leading consumer packaged goods company with a portfolio of good for you and good for the planet consumer-branded products. Sprout Organics is a top 5 organic baby food brand that is currently outperforming the category in sales growth. We have recently made a successful expansion out of the baby aisle into a new product category, Toddler Meals, Biodroga is also performing well with new product offerings and new client relationships. I will go into both of these as well as operational highlights right now. Let's start with our organic children's food and snack brand, Sprout. According to Nielsen data, Sprout is the fastest-growing brand out of the top 5 brands in the organic shelf stable baby food category, growing 26% in the last year outpacing Gerber Organics and Happy Baby Organics. Nielsen data last 52 weeks, week ending October 8, 2022. Specifically, within the latest quarter, updated Nielsen data shows that Sprout sales grew 18.6% versus 10.7% for the overall category. Nielsen data last 13 weeks, week ending October 8, 2022. Our CoComelon partnership has proven highly incremental to the category. CoComelon snacks are turning 79% above the category average, in the last 13 weeks. Pouches are selling 40% above the category average of all pouches. Nielsen data last 13 weeks, week ending October 8, 2022. Sprout has the 3 fastest-growing organic meal items nationally and the highest velocity in the segment. Nielsen data last 13 weeks, week ending October 8, 2022. While we experienced quarter-over-quarter sales growth, our everyday fill rate fell to 57% in Q2 due to supply chain challenges. Our biggest supply challenges were our Stage 3 pouches and Toddler meals and our waffle supplier, which experienced a fire at the facility and unexpectedly caused out of stocks. With ingredients already back in stock, we are catching up on this as is evident in our October fill rate, which is back up to 81%. Sprout continued to roll out new SKUs during the second quarter, further increasing our opportunity for revenue growth. Last quarter, we announced the addition of a new display featuring the CoComelon co-branded product at 2,500 Walmart doors in August and September, which was a major contributor to an approximate 31% increase in net sales for the first half of this year versus the same time period during the prior year. We are gearing up for distribution expansion in Q4 as we are doubling our SKU count and more than doubling our door count from 900 to 2,300 doors with a major retailer, Sprout's distribution growth in terms of store count has reached nearly 28,000 doors. We are now available in 90% of the market partnering with leading retailers, Target, Walmart major supermarket chains and both of the largest national pharmacy chains in the United States. We are also shipping direct to consumers through the Sprout website. Sprout is now available in all 50 states and continues to expand in Canada. In Q2, Sprout expanded beyond the baby food aisle, and continues to show upward trends, strengthening our potential to disrupt growing addressable markets. For the first time, since Sprout's inception, they will now be able to extend its customer lifetime value providing healthy, organic and convenient options as children grow. The launch of our new big kids meals, a line of organic heat and serve bowls for children 4 and older is a key milestone toward the company's plan of extended market penetration beyond the baby aisle. The launch includes 4 flavors, each with a full serving of veggies and represents our potential to disrupt a retail category, more than double the size of the baby food category. Big kid meals have already begun shipping to retailers, and we expect to report revenue growth in upcoming fiscal quarterly reports. The second fiscal quarter of 2023 saw a continuation of Sprout's growth path with several exciting milestones and sales levels achieved. The Sprout brand recorded $8.4 million in revenue in Q2 of fiscal 2023, outperforming Q2 and fiscal 2022 by 19%. We saw improvements while pulling back on promotions. The first half year-over-year trade rate was reduced by 10 points. We made significant improvements in gross margin this quarter and expect fluctuation in future quarters as we progress towards our plan of 22% in 2024, largely driven by the following 4 key drivers: one, improvement of the distribution and warehousing costs as a result of the move to a full turnkey model as well as improved logistics cost management. Two, continued price increases effective November 1, 2022. Three, an improved product mix. Four, the realization of certain volume discounts with the level of sales increasing. As well we are gearing up for distribution expansion in Q4 as we are doubling our SKU count in more than doubling our door count from 900 to 2,300 doors with a major retailer. A key element of Sprouts strategy focuses on accessing the growing organic food and beverage market with Nielsen estimating market size of $124 billion and $21 billion for beverages and cereal, respectively. We continue to seek relevant opportunities to launch new products into categories where we see the most potential. Our expertise and partnerships with retail leaders gives us the foundational position toward becoming a leader in the organic food sector and beyond. We are focused on scaling the Sprout business in a cost-efficient way while also growing and innovating within the organic food market. I am very proud of the momentum the Sprout team has continued over the second quarter and we look forward to continuing this through fiscal 2023. Turning now to personal care and beauty and Biodroga. Steps we have taken over the past year to increase product lines and grow sales leads have continued to translate to positive sales in the second quarter that we expect to continue through fiscal 2023. This was achieved by amplifying Biodroga's brand presence through trade show attendance, implementing effective marketing strategies and our launching of a successful new website in prior quarters. We have continued to innovate and grow Biodroga's product lines for both existing and new customers, which will further drive revenue going forward. Our MaxSimil Omega-3 products have also maintained significant popularity and customer demand with a new customer secured in the second quarter for a whole new portfolio of products to be launched shortly. Biodroga also continues to undertake clinical studies to further build the credentials of our MaxSimil technology, which we believe is an incredibly strong asset for the company. MaxSimil is a game-changing piece of biotechnology that will help grow Biodroga and increase its market presence long term. MaxSimil's technology has been successful in making fish oil 3.5 times more absorbable than standard fish oil, and we hope that with our ongoing studies, we will be able to expand MaxSimil into more nutraceutical products. We're tremendously excited for what's ahead for Biodroga and look forward to seeing continued growth from them. Our consumer personal care brand, Forest Remedies, also continued its path of growth during the second quarter. Product launches of Forest Remedies into large retail chains nationwide have translated to positive sales growth, which we expect to continue through fiscal 2023, in particular, launches into Sprouts, farmers markets, Fresh Time and a large pharmacy chain in prior quarters have translated to week-over-week growth and strong customer demand. In addition, Neptune is working on the development of innovative new SKUs in the product pipeline for Forest Remedies. For example, we are planning to launch Forest Remedies multi Omega kid gummies early next year, the formulation for which has already been developed. While we continue to experience sector-wide supply chain issues over Biodroga and Forest Remedies, we have been aggressive in implementing streamlining and efficiencies to mitigate these challenges and ensure cost saving. Biodroga continues to expand its manufacturing network by developing strong partnerships across North America. And during Q2, Biodroga launched its first product from a new softgel manufacturer in the U.S. Product quality remains a key pillar for Biodroga, so the selections of new co manufacturers are carefully managed by our quality team. To conclude, Neptune made significant progress over the second fiscal quarter to execute on its consumer packaged goods growth strategy and improve our path to profitability. Our progress has been demonstrated by sales growth across both our organic foods and beverages and personal care and beauty. We are well placed for growth and believe these decisions are in the best interest of Neptune and its stakeholders. Thank you to all our teams at Neptune, as well as our stakeholders. The last few years have been hard on us all, but finally, there's a light at the end of the tunnel. By exiting cost-intensive businesses that were championed by our prior Boards and leadership, we are now finally able to say that we believe we will be on the path to profitability quicker, slimming down, starting to simplify the organization and focusing on consumer packaged goods is the company's future. I will now pass the call over to our Chief Financial Officer, Raymond Silcock, to discuss our financial results in more detail. Ray has had a successful career improving sales and profit performance for leading public and private equity-owned companies, including Campbell Soup and Diamond Foods. We are pleased to have him join us. Ray? I am pleased today to present Neptune's financial results for our fiscal second quarter of 2023. The three-month period ended September 30, 2022. All amounts are in U.S. dollars. First of all, I'd like to sincerely apologize to all our shareholders and to our other stakeholders for the delay in reporting earnings this quarter. The delays were largely as a result of complications from our transition last year and from Canadian to U.S. dollar reporting as well as from our onboarding and new finance and accounting team this quarter, including myself. Turning now to the results for Q2. Revenue for our second quarter totaled $12 million, a decrease of 4% from the same quarter last year despite the adverse impact on net sales of our existing the cannabis business. The cannabis divestiture resulted in a reduction of net sales of $600,000 in Q2 as compared to the same quarter last year. This decrease was more than offset by increased net sales from the key growth segment of our business, organic foods and beverages growth we expect to see for the rest of fiscal year '23. Consolidated gross margins in Q2 improved by 18.6 basis points to 9.2% of net sales for the second quarter as compared to a negative 9.4% of net sales during the same quarter prior year. This improvement reflects that Q2 last year included the impact of a $3 million impairment to cannabis inventory as well as the effects of steps that were taken over the past year towards becoming a pure-play CPG company, which have translated into margin growth in organic foods and beverages, where our principal brand is Sprout. On Sprout, we expect to see a continued favorable impact on both revenue and margin as we scale our co-manufacturing and retail partnerships there. Sprout and organic children's food brand accounted for $8.4 million or 70% of the total $12 million of Neptune revenue in Q2. The principal driver of Sprouts growth in Q2 was in Walmart displays, which we secured in 2,500 Walmart locations last -- this past quarter. Moving now to Biodroga. Biodroga's Q2 net sales were down $900,000 from the same quarter last year, adversely impacted by shipping delays. Gross margins of 29% compared to 30% for Q2 last year. And finally, cannabis. The sale of the cannabis assets for $3.8 million was completed on November 9, 2022. Q2 cannabis revenue was $55,000, a decline of $1.1 million as compared to the same period last year, while gross margin improved $420,000 to a loss of $780,000 versus a loss of $1.2 million in the same period last year. Exiting the cannabis business was a significant milestone for Neptune as divesting the cannabis assets has freed us to pursue relationships with investors, corporations and banks who have restrictions against working with companies that own and/or operate cannabis businesses. Even more importantly, it maintains our focus on our growth business, Sprout as well as on our Canadian business Biodroga. Additionally, the sale of cannabis assets has helped us realize significant cost savings and will enable us to streamline our business model and enable simplification of our corporate structure. Year-to-date fiscal year '23, Neptune net sales of $28.3 million, up $5.7 million versus the same period last year, an increase of 25%. Gross margin year-to-date amounted to a loss of $1.8 million compared to a loss of $3.5 million for the same period last year. Excluding this year's cannabis -- this year's first quarter cannabis inventory impairment charge of $3.1 million, gross margin for fiscal year '23 year-to-date would have been a $1.3 million profit. This compares excluding last year's $3 million inventory impairment charge on cannabis, to a loss of $500,000, excluding the impairment in fiscal year '22. Moving on to Sprout. Net sales for the first half of FY '23 increased by $3.9 million compared to the same period in the prior year, an increase of 30.5%. This was largely driven by our diversifying into new product categories, in particular, to what we call Up-age Meals, meals for older kids by expanding our distribution with footprint -- excuse me, by expanding our distribution footprint with Walmart and also from increased prices. These factors all contributed towards market share growth, higher sales revenue and margin improvement as compared to the same period last year. Gross margins have already improved sequentially quarter-over-quarter in fiscal year '23 driven by higher sales volume and increased selling prices, and we expect further gross margin improvement for Sprouts in 2023 from the 4 key drivers that Michael enumerated in his remarks. We anticipate that these drivers will lead to a Sprout gross margin of 22% by the end of fiscal '24. Biodroga net sales year-to-date totaled $8.2 million, an increase of 13.7% compared to the same period last year, while gross margin of $2.0 [ph] million in Q2 was up from $1.9 million last year. The percentage margin for Biodroga expanded from 31.6% year-to-date fiscal '23 -- sorry, expanded to 31.6% fiscal '23 from 26.2% last year. In the second quarter, SG&A expenses were $15.9 million compared to $15.4 million for the same period last year. This is primarily as a result of severance payments, mainly in the cannabis business and other costs related to our restructuring implemented over the past year. Net loss of $37.3 million in the second quarter was primarily due to an impairment charge in Q2 of $24.7 million, $10.2 million of this was in Sprout trade names and goodwill and $14.5 million was related to the cannabis assets we sold. In addition, we had a change in the fair value of derivatives, which cost $7.3 million, offset by a gain of $3.1 million in foreign currency adjustments. This compares to a net loss of $12.1 million for the same quarter last year. We have also continued to take action to manage operating expenses, cost cuts across the businesses and at corporate, have reduced the company's headcount from 170 to 56, a payroll reduction of $7.6 million or 49%. In fact, since completing our strategic review last year, we have reduced our total admin pet spend by an approximately $18 million on an annualized basis. We continue to evaluate additional steps to manage all our expenses appropriately, and we expect Sprout to have positive EBITDA by the end of fiscal 2025. Turning now to our balance sheet. Neptune ended the quarter with $1.4 million in cash on hand. Today, our cash on hand amounts for $3.5 million. In July, Neptune entered into an amendment and expansion of Sprout secured promissory notes, led by a $3 million investment from Morgan Stanley. This amendment expanded the notes by $15 million from $22.5 million to a possible maximum of $37.5 million and signified confidence in Neptune's strategic shift towards becoming a pure-play CPG company as well as Sprouts growth trajectory. The funds from the expanded facility are intended to be used for general Sprout working capital and the repayment of certain outstanding obligations. In addition, Sprout introduced -- excuse me, Sprouts issued promissory notes amounting to $775,000 to other investors since July 2022. And in October of this year, Neptune raised $6 million in gross proceeds in a successful public offering of the company's equity. To sum up, we are pleased with the year-to-date progress on our core brands, Sprout and Biodroga, increased revenue, better gross margins and lower costs, a pattern we expect to continue through the rest of this year. We are now directing all our focus and resources to becoming a CPG company and look forward to seeing this improvement as we advance into the next fiscal year, fiscal 2024. Good evening and thank you for the questions. So first one for me. I believe you guys said in the prepared remarks, there was some impact just in terms of supply with -- I think you said some waffles and the toddler on the Sprout side. So can you talk about maybe how much of an impact that might have had in the sales during the quarter? And then just maybe just give us some more detail on the impact and confirm that, that's now been resolved? Thank you. Hey, Aaron, it's Michael Cammarata. The impact, we had a fill rate of 57% for the quarter of the potential orders. So obviously, there was -- if you minus out the 1.2, 1.3 of Walmart, you can see the core impact it had on the core sales. We are since back up to over an 81% fill rate and with the goal of getting up to over 90%. Okay. That's helpful. Sounds like you guys got some extra distribution coming online in 4Q with retail going from 900 to, I think, 2,000 or more. So can we confirm that, that Sprout organic distribution now being at 90% that takes into account that incrementally have coming on -- I'm sorry, in calendar 4Q, not your fiscal Q. But can you confirm that, that includes 2,000 and 90%? And then as we then move forward into the incremental quarters now that you have the broader distribution of the 90%, is it then more about getting more SKUs within the existing doors? Or how do we then think about those incremental growth opportunities for Sprouts? Yes. So with that retailer, particularly the resets are in March, so we would ship out in February, and that would be the uptick, which is in our Q4. Okay. In your Q4. And then -- and how do we think that gets you to 90%, right? So then thereafter? How do you think about more longer-term growth opportunities for Sprout? Yes. So the growth opportunities, obviously, we're heavily focused on increasing our velocities and our SKU expansion. So with our Up-age Meals, those are starting to roll out to our core distribution. So that's something that beyond our core SKUs, the Up-age Meals, we expect to roll into the existing distribution. It's already started shipping and will start ramping up early next year. And then on top of that, beyond the Up-age Meals, we have additional distribution that's coming online for additional retailers. Obviously, our white space that we have is in Albertsons and Whole Foods. Okay. Great. Thanks, Michael. Any update in terms of the partnership with CoComelon and maybe how some of the CoComelon and co-branded products might be outperforming, maybe some co-marketing, you might -- I know there's some potential for that. So any update in terms of that CoComelon partnership? Yes. So CoComelon, we haven't even deployed yet marketing into the YouTube channel yet, which has over 115 million subscribers. We are expanding our relationship with them and with an addition of additional products, including the snacks that we announced going into our distribution. So the partnership we're seeing that there's an uplift of over 70% on the SKUs when adding the CoComelon. So we're seeing that we're performing very well against our peers who have different licenses. So CoComelon is proven in retail to increase distribution and have an uplift that is greater than 70%. We are expanding the relationship and the product offerings with them. And then we do plan to expand the relationship and how we market with them as well as starting to eventually work with them on the YouTube channel and integrating additional content as the SKUs roll out to our distribution. Okay. Great. Thank you for that. And then last one for me, and then I'll go ahead and jump back into the queue. Just talking about the target, this might be more for Raymond here, the target of the profitability by end of fiscal year 2025 on EBITDA. First of all, could you just confirm the EBITDA for the quarter that you guys had roughly here? I didn't see that in the PR. And then as we look to that in the fiscal year 2025, can you talk about maybe some underlying sales or gross margin assumptions that might be needed in order to reach that profitability target? Thank you. Yes, this is Ray. I -- we'll be releasing our Q with EBITDA detail in it on Monday, but I'm not ready to answer the EBITDA question right now just because we didn't include that in our press release. So with respect to the question about profitability in '25, yes, we have expectations. But right now, we're guiding totally to our expectation of profitability in '25. And at some future date, we might be willing to give more detail. But right now, we're just sticking with the fact that we expect to be profitable and not the full details of sales and earnings and so forth. [Operator Instructions]. As there are no further questions, this will conclude the conference call for this afternoon. Neptune would like to thank everybody for participating, and we ask you to kindly disconnect your lines.
EarningCall_1481
Good morning. My name is Lisa Gill and I'm the healthcare services analyst with J.P. Morgan. It is with great pleasure this morning that we have with us Cardinal Health. Presenting for Cardinal Health is CEO, Jason Hollar. Post Jason's presentation, he and I will sit down for a quick fireside chat. Jason? Thanks, Lisa and good morning everyone. Thanks for joining us today. Let me get a few things out of the way here before I begin. I will be making forward-looking statements today. These forward-looking statements are subject to certain risks and uncertainties that may cause actual results to differ materially from those projected or implied. For description of these risks and uncertainties please refer to our Investor Relations website or to our SEC filings. So, let's get started by going through a little bit of background for those of you that are a little bit familiar to Cardinal Health. We are essential to healthcare and we have the privilege of serving one of the broadest, widest range of customers and partners in the industry. We are a crucial link between the clinical and operational aspects of the healthcare ecosystem and deliver end-to-end solutions to our customers that advance healthcare and improve lives of the people every day. And we have scale across the spectrum that you see on this slide being relevant in each of these categories. Whether you are talking about the several thousand manufacturers that we work with every day or the tens of thousands of pharmacies that we provide products to, or the millions of patients that are in the home, we have scale across the spectrum. But in addition to the scale, we're also aligned with a lot of the key secular trends in our industry. Let's start with patient demographics. We all know the stats. Americans over the age of 65 the real sweet spot of the healthcare industry is expected to increase by nearly 50% from 2020 to 2040 and that creates an interesting opportunity for us. Obviously, there is a lot of volume that comes along with that, but what's also terrific about that volume is there's much more resilient, stable, and predictable than what we see in other industries and this is a real boon to our underlying volume across many of our different business segments. At the same time, we're seeing unprecedented levels of scientific advancement and new drug development. This of course creates opportunities for us, again volume is a key driver of that, but also brings with it other services and support beyond just the delivery volume into higher margin, higher value categories for our customers. Some examples of that will be of course new biosphere launches as the biosimilars move into new therapeutic areas and size of care, we're well positioned in these areas as well as other novel therapies such as cell and gene. And underlying all these growth areas are the services and support that I referenced earlier such as our industry leading 3PL. Whether it's that aging population or COVID-19 or other value-based care models, we do continue to see the site of care shifting as well. And this is often to lower cost settings such as the home or ambulatory surgery centers, both areas that we have good scale in. Specifically, to our At-Home business we're now at nearly $2.5 billion and growing that top line very consistently at 10% per year as we continue to benefit from that shift of care into the home. And then finally, as with other industries and accelerated by the pandemic, we're seeing technological advancements results in the increased digitization of healthcare with a specific focus on creating a tech enabled supply chain which provides new data and analysts capabilities for both ourselves as well as our customers. Now stepping back, as a result of these specific capabilities for Cardinal Health as well as the secular trends throughout the industry we've benefited from this growth over time and are now exceeding $180 billion in revenue per year while operating in more than 30 countries throughout the world and a team of more than 46,000 people. We're organized into two key reporting segments. The largest by far is our Pharmaceutical segment representing about 90% of our revenue for the enterprise. The earnings for the Medical segment has been adversely impacted by inflation and supply chain constraints throughout the globe and I'll get into some details shortly on the initiatives that we're working through to improve those results. So, let's start with a deep dive into the Pharma segment and within the Pharmaceutical segment I'd like to start with just reminding some of the recent highlights of some of the changes that we've made soon after my appointment in September. I appointed Debbie Weitzman as the new Pharma segment's CEO and also announced a corresponding restructuring of the organization. We brought the specialty and pharmaceutical distribution team together under one umbrella which reduces complexity, improves both the speed and the quality of decision-making, drives productivity, and importantly provides an environment for direct accountability within the business. At its core the pharmaceutical and specialty distribution business distributes branded generic and specialty pharmaceuticals as well as over-the-counter consumer healthcare products. As I mentioned before, we have a strong broad customer base from the largest retail chain customers to the smallest retail independent customers. Specialty is a critical growth area for us, both in oncology as well as the other therapeutic areas such as rheumatology and in addition to this recent services we brought other service capabilities as per our customers offerings such as our GPO services as well as technology capabilities like our new CTS technology platform. As part of the restructuring that I referenced in the Pharma segment we did create a more focused team for creating the sourcing and manufacturing services organization. This takes a holistic approach with manufacturers from the development, commercialization and distribution, more of the full-line supplier there and from a sourcing perspective of course we have our Red Oak Sourcing joint venture of CVS Health that has the dual mandate not only of controlling costs, but also to maximize the service delivery for our customers. Beyond that we also support biopharma manufacturers, a full range of other services such as the 3PL I mentioned, as well as other services like data and evidence solutions, commercialization support and others. Within the Nuclear business we do operate the largest network of radio pharmacies in the United States. Our core business here is getting those radiopharmaceuticals to the end user, but we've also recently extended the business to be more of an end-to-end innovation partner with our manufacturing customers. This is primarily through some significant investments that we've made in our Center for Theranostics Advancement in Indianapolis and we support these manufacturers through contract manufacturing and drug development. This is a key part of our growth strategy for the Nuclear business, but we also invest in other areas like our [indiscernible] capabilities and other innovation and a combination of all those items is why we have confidence that we can double the profits of the Nuclear business from fiscal 2021 to fiscal 2026. Final business there, our Outcomes business is that digital ecosystem that's designed to build that connectivity across the industry landscape that I referenced on the first slide, connecting the manufacturers, payers, pharmacies and patients. Now moving on to the Medical segment, I will start with the medical products and distribution. Here we manufacture, source and distribute our Cardinal brand portfolio of products, $4.6 billion portfolio, focus on medical, surgical and lab products. They range from consumable products like PPE, all the way to more clinically differentiated products like operating room and recovery room products, surgical gowns, nutritional and enteral feeding products, as well as compression devices just to name a few. We support and again another broad range of customers, large hospital systems, ambulatory surgery centers, clinical labs. Next, we have our At-Home solutions business. I already referenced that a few times on those secular trends. This business delivers products and service customers and patients directly in the home and is on that key trend. A lot of products here include ostomy, nutritional and diabetic supplies, and it is a key strategic area of focus for us, not just because of our right to win there with our capabilities but also again with the secular trends. The final businesses there, the medical services, these are businesses that trend that capitalizing the trend of digitization of healthcare and include our OPTiFreight business is by far the largest with that. And this is providing data-driven supply chain solutions, just another way of saying that we help our customers reduce their fright costs which of course is even more important in this environment. Over the last 18 months or so the medical business has been dealing with the effects of the global supply chain constraints and inflation and that was largely on the Cardinal Health branded products, a lot of the national brand products could pass through the cost plus, but our own brands we tend to have longer term contracts in place which means it takes some time for those price adjustments can occur. So, with that challenge and in conjunction with my permanent CEO I announced a detailed medical improvement plan a couple of quarters ago targeting at least $650 million of segment profit by fiscal 2025. And given the importance of that, sort of initiatives let's go into that a little bit further. So, the key driver of the challenge is the global supply chain constraints and the inflation. So that's the number one area of focus for us is to mitigate that to eliminate that $300 million headwind that first originated in fiscal 2022. It's a similar sized headwind for us in fiscal 2023 and our objective is to eliminate that by the time we get to fiscal 2025. And this is through pricing actions as well as other commercial strategies to offset. We are making good progress. My reference last quarter Q1 that we had mitigated 25% of the gross impact of inflation and that we expect to exit fiscal 2023 mitigating 50% and then further mitigation to eliminate the entire $300 by the time we exit fiscal 2024. Also, our mitigation actions for inflation we expect the next largest contributor of growth by 2025 to be optimizing and growing our Cardinal Health brand portfolio that I already referenced earlier. This is to be achieved through new product innovation as well as increased product availability through targeted capital investments. Next is accelerating our growth businesses back to At-Home solutions business there, continuing that 10% topline growth to drive value over the next few years. And then finally driving simplification and cost optimization. This is beyond just the Medical segment, but it is a component of our turnaround plan here. One example is the medical, nonmedical grade gloves portfolio that we recently exited as a good example of our actions to not only reduce the impacts of those issues, but also to de-risk our operating model going forward. Okay so now enterprise level our key strategic priorities as you can imagine, first and foremost is executing upon that Medical segment improvement plan. So, I think we've been through that enough, but that is not only important for the Medical segment, but clearly the top objective for the enterprise given the magnitude of inflationary impacts. But we can't look past the fact that our Pharma segment is by far our largest business, 90% of our revenue and a substantial part of our profitability. And here we're very pleased with the ongoing stability that we're seeing in this business, not just with the underlying volume, but also with consistent dynamics of our generic’s programs. We did see some volatility in this business over COVID specifically in our fiscal 2021 and we have seen that over the last 12 months really get back to much more normalized levels and to build upon that momentum we continue to focus on the core operations of this business driving improvements through investing in and prioritizing our customer experience as well as reducing the organizational complexity through the restructuring I referenced and driving other productivity and efficiency gains. Within our growth areas we're focused on our specialty business. It's by far the largest and still growing very strongly. I mentioned earlier the organizational changes are very much focused on getting more effectiveness out of that organization and more access to the investments necessary to grow. But we also do, also continue to look at other growth areas such as inorganic investments in downstream. One good example will be our recent acquisition of the Bendcare GPO. Lastly, through the new sourcing and manufacturing services organization, we are building that end-to-end manufacturer strategy to ensure that we deliver value to those customers. Finally, and certainly not the least is the relentless focus that we have on shareholder value creation. It all starts with the first two strategic priorities in driving the appropriate growing profitability and cash flow, but then it's reinforced by the responsible return of that capital to our shareholders. So, for example, we continue to guide for $1.5 billion to $2 billion of share repurchases this fiscal year and that's on top of last year's $1 billion of share repurchases and in addition to the $500 million per year in dividends that we pay. So far for this fiscal year we announced that we had initiated a $1 billion ASR in the first quarter. We did increase that with another $250 million in the second quarter. And in addition to all of that we've also further enhanced our governance structure with four new independent directors as well as the creation of the business review committee focused on both the operational strategic aspects of our business and of course the portfolio review. We do plan on having an Investor Day by then in the fiscal year to take you through some of those aspects further. Sorry I missed a slide there. So, before I wrap up one important note as it relates to ESG. We are committed to a more sustainable and equitable world and we've established our ESG initiatives accordingly and that's depicted here in front of you on this slide. So, we're making progress against these targets which we'll detail in further ways with our new ESG report that will come out in just a few weeks. But what you'll see in this report in how we're approaching ESG is that we do believe that we can simultaneously drive improvements in these ESG initiatives in support of and not in conflict with our overall business transformation. So, we believe that can be win-win. Okay, so let me just close by explaining further why I'm energized by my role here at Cardinal Health and why I believe that we're compelling investment opportunity. First, and we continue to see stability in our largest business. Our pharmaceutical distribution and specialty distribution business continues to have tremendous stability much more predictability than we've seen more recently and again back to the generics program continuing to see consistent market dynamics. This was off of a pretty good year last year even in spite of the inflationary pressures we saw in fiscal 2022 for the Pharma segment. We're able to grow that business bottom line by 5%. We had similar growth in the first quarter of 2023 and we have guidance for fiscal 2023 that is consistent with our long-term financial objectives of low to mid-single digit growth there. Next and importantly, we have a very clear robust plan to mitigate the impacts of inflation of the Medical business through the medical improvement plan and to delivery at least $650 million of profit, segment profit by fiscal 2025. Next we have the secular trends that I referenced before in healthcare that provide long-term tailwinds to our businesses notably our growth businesses are on those secular trends for the Pharma business. That's primarily the specialty business and for the Medical businesses that's the At-Home solutions business. And we expect that as these businesses continue to grow that they would be a larger and larger contributor to our underlying earnings. We also continue to operate with urgency as it relates to the simplification of how we operate as an organization. You'll hear me talk a lot about efficiency versus effectiveness and most of all these reorganizations and restructurings do bring with it some level of cost savings and efficiency, but I believe firmly that we get at least as much value as it relates to the effectiveness of these changes back to this quicker decision-making, better decision-making and holding ourselves accountable to those results. We are clearly focused on cash conversion and continue to generate that robust cash flow to provide the financial flexibility for that capital deployment. And here we continue to look at those various alternatives and see that, sorry, purchase I referenced earlier have been a key component of that, and we'll continue to look at those priorities. So, overall proud of the progress to date. I recognize that we still have some work to do, but I'm really excited about what comes next for the organization. In-person and we've done a number of calls together over the last couple of years, but it's been a few months since you took the lead role as CEO of Cardinal. Maybe just reflect on a few things. One, what have been some of your biggest take away sitting in this seat versus the CFO seat? And then secondly from a strategic standpoint, where are you most focused? Yes, so there's not as much different as what perhaps there would have been the perception, because some of these initiatives I'd already had the momentum going in the old role. The medical improvement plan is something that right out of the gate was really important for us to not only put a clear line in the sand as to where we're going, but make certain that we have the resources and the attention to it. So that was a key component and of course we've streamlined the organization in a number of ways. The internal organization hears me talk a lot about simplification, prioritization, everything that we do to, again not just take cost out, but to ensure that we are moving with speed. And so, I think where we go from here, I'm really proud of the fact that we made a lot of those changes very quickly. So, within the first month or two there was a lot of change. We had some organizational changes. We chose to exit some product lines in the Medical business, but the Pharma business continues to operate quite effectively with a strong volume, but those organizational changes happened quickly and then we all got focused to getting back to business as usual and we want to make tweaks along the way, but I think what you're going to see is that we've clearly defined where we're going, what the objectives are, what the plan is and it's really at this point all about execution. You talked about capital allocation and talked about the $1.5 billion to $2 billion of share repurchase. As we think about the assets that you have today, do you feel like you have everything that you need? Is there areas that you would think about from an acquisition standpoint? And beyond share repurchase how we think about the capital allocation priorities that you have in place? Yes, I think we have in the first slide I showed, demonstrated we have really great breadth in the industry. There were some things that we had to divest in the past and we had three divestures over several years that generated $3 billion of proceeds. So, there were some things that did not fit. We will continue to look at that, but at the same time there's nothing that we are missing that we need to be successful. There are going to be areas that we'll want to augment. More recently you saw that we did a relatively small acquisition in the specialty space with the Bendcare GPO and that's a good example of the type of opportunity we have that can accelerate further, but when I look across the spectrum it would be plugging into those growth areas and not taking us down a different path. We are going to be very focused on what we do and what we do well that core and when we grow or when we really, really focused on very few areas, but prioritize those areas and invest more heavily, both organically as well as inorganically. That makes sense. I've followed Cardinal for a long time and watched them bear down that path whether it was to China or the Cordis that we didn’t know you're thinking about the best thing… The phrase, focus on the core comes up every single day in this organization, and that is -- it can evolve and morph a little bit, but we will -- we have $180 billion plus of revenue. We have enough customers, enough products, what we need to do is be more effective and efficient at delivering those products and services. So as we think about the Medical Improvement Plan, what are the factors that could impact you reaching that $650 million of segment profit by 2025? I think if there’s one area of push back, I’m sure Kevin tells you this, you probably hear from investors as well is just really getting our arms around that and feeling comfortable and confident around that number, even though it’s a few years out. Sure. Yes, and it’s materially different than where we’re operating today. So we understand that, and that’s why we laid out the detail we did, the four point plan to get there. And of course, within that, two-thirds or so of the actions are in one category, which is to ensure we get the pricing and other commercial actions to mitigate that inflation. And that’s the biggest point is we are in the middle of the supply chain and there’s no reason that the inflation should stick with us. It needs to get pushed down. There are reasons why it’s not simultaneous, and we are working on more permanent changes to the contracts to ensure that that’s the case. But in the meantime, we are working with the GPOs and our customers to find the right path, but we’re confident that’s the right answer long-term, and that’s why it’s a key tenet of that plan. But there -- so within that, to get to your question, there’s things that can change with inflation, right? None of us know exactly where inflation is going, but what’s important is we have a process in place that allows us to pass through those impacts more quickly. And of course, first and foremost, to make sure we get this first $300 million remediated. So having the right structure there is important. Within the other key piece is the next largest is, of course, Cardinal Health brand volume. That’s a component that the innovation and the investments in the product is completely dependent upon this management team to get that done. There’s an underlying volume utilization that is going to be a component of that. That’s about half and half. Half of it is the mix that we’re driving and about half of it is this underlying volume and over longer periods of time, given the demographics, we think that there will be a tailwind there. So, there’s always been a focus on the Cardinal brand product, right, since buying Allegiance all those years ago. And the penetration of Cardinal brand products have never really dramatically increased. Is that because Cardinal just didn’t make the investments needed for the next generation of private label product or was there something else that is changing now that you feel like that penetration can increase? Yes, there’s very specific things that we are doing to drive that, the innovation is part of it. So, there’s innovation, there’s also capacity. So especially with the pandemic, there was a delay in terms of what we were able to execute. Our customers didn’t want to talk about transitioning to our own products. They wanted to talk about just how do I get product. So now that we are through the worst of that element of the supply chain constraints now is the appropriate time to again sell that concept to our customers. There’s value for them to have those products, but we also need to invest in the capacity because especially with the supply chain constraints, part of our challenge has been we’ve not been able to deliver as much product as what there’s demand for and then combine that with further innovation to further spur that demand. But remember, we’re talking about a 3% annual CAGR. A couple of points is the market, one to two points is that mix. So, we’re not talking about dramatic movements that are needed, but an evolution. And given the fact that we are underpenetrated, we believe right now, that’s a real opportunity for us. There’s been some question in the marketplace around now destocking for these hospital systems that they were taking hotel rooms and other places and putting as much PPE as they possibly could get their hands on. And I know talking to yourself and your predecessor et cetera, that in many cases, that wasn’t Cardinal’s product because you were in a position that you were having difficulty getting product as well. What are your general views on destocking in the marketplace right now? And does that view change versus my perception of what has been said before around how much of your product could potentially be in the channel today? Yes, so there’s a lot there. So, PPE -- so there’s not any new news here as it relates to PPE. So, what we said last quarter is that we believe that the low point of the demand pull from our customers to us was at the bottom in the fourth quarter. So, you heard us talk fourth quarter 2022. You heard us talk about some volume challenges with PPE in Q3 of 2022. It got worse in Q4 2022. It got a little bit better last quarter. And what we’re seeing is that our customers probably in the fourth quarter of last year finally started to hit those restocking points, where they were using PPE at a pretty consistent pace is just that they didn’t need as much. So that destocking is happening very consistent to our expectations. We expect it to be a slow improvement. Different customers, different products, right? They may have enough of one, but not enough of another. Generally speaking, they’re still holding more than pre-pandemic, but it’s also getting -- the pendulum is swinging a bit back the other direction. And the other key thing as it relates to the Cardinal Health story here is remember that PPE has never been a category that we’ve ever made a significant amount of money on. It’s not a category. It’s a commodity product. It’s one that’s important to our customers. So, we want to support them, we need to have the full line. But as that volume fluctuates, it was really more of a challenge because we had volume fluctuating, price fluctuating and costs fluctuating. So, it created wild swings in profitability quarter-to-quarter on a product line that typically had very little difference as it relates to those types of margin swings. Do you feel that coming out of the pandemic, the competitive market has changed at all when we think about being a medical supplier? And I agree with you that when you look at Cardinal historically, a lot of your medical supply business was not just that traditional PP&E, but rather the surgical kitting and other higher-margin types of products. So, do you feel though that relationships have changed at all or the competitive market has changed at all? Well, you’re asking the question to someone that wasn’t here pre-pandemic, but what I can tell you is that even in the time period I’ve been here, the relationships, they evolve, but where the medical healthcare industry is right now is where I think most industries are. Customers want product at a great cost at great value and delivered on time and de-risked. And so, with the pandemic through a lot of things upside down, where you could get the one of those, but not all of those out at the same time. And so, it’s up to us and the industry to continue to demonstrate to our customers that we’re focused on our core. We’re focused on investing in our distribution channels, our products to ensure that they have access to the products that have great value for them. So, kind of switching gears a little bit to talk about the pharmaceutical side of your business, which has been nicely stable, which has been a great business. Just really a few questions here. So generally, this week, we start to hear price increases for the pharmaceutical manufacturers. I know not as big of a swing factor for drug distribution these days, but has that come in largely in line with your expectations? Yes, I think the word is largely in line is right. And the main point is exactly how you framed the question, Lisa, is that this is certainly less than 5% of our brand margin, and it continues to be a smaller and smaller part. We continue to go to more and more direct fees. So, it’s relatively small and it’s in the ballpark of what we expected. Has it surprised you on the generic side that we’ve seen inflation everywhere but in generics. And so, when we think about generics, and I just really question how these generic manufacturers make money, like just given the amount of pressure we continue to see on pricing and the overall cost environment that we’re in today, what are your more broad thoughts on generic pricing? And could we potentially see some level of inflation in 2023, calendar 2023? Well, it’s not something that we spend a lot of time thinking about because we’re Red Oak Sourcing is absolutely focused on driving down the costs, also remember, it’s the domain. It’s driving down costs. It’s also maximizing that service delivery and having the best service possible to our customers. But what we see is they continue to find opportunities in the marketplace. It is a large industry, a large market with a lot of very capable suppliers. And so we want to continue -- we want to see them healthy. We want to work with them. But ultimately, what we see is still some opportunity to always continuously improve. But when we look at the underlying performance of our generics program, we don’t like to break it apart into the pieces because what Red Oak’s performance is very much based upon how well they’re doing relative to others in the industry, which is more of the spread. And so we continue to see, and that’s why we used the reference consistent market dynamics is to indicate that, that spread continues to be as expected. Any surprises or any updates on the Red Oak side? I mean, if I remember, I think that agreement was signed long before your time, 2013? Well, we renewed it about a year ago, a year and a half ago, and then it took it through June of 2029. So, it was a long -- it is a long-standing relationship. So no, there’s no surprise or changes. And I think the fact that we renewed it more recently well in advance of when it expires is highlights that it’s working for certainly our organization. One of the things that we’ve written about recently have been flu. We’ve been tracking the flu pretty closely. My understanding for drug distribution is that any incremental volume is good, but flu is not a huge driver of volume. So maybe can you just talk about what we’ve seen more recently for volume overall and is my assumption correct? Your assumption is correct. It’s really not a needle mover for us. It’s one of many different products and product categories. So overall, for volume, as my prior comments, we’re pleased with the stability that we’re seeing, and that’s the most important thing for us is that we see predictability, consistency within that demand. And overall, there’s pluses and minuses any particular quarter. And this -- what we’re seeing for the last 12 months really is some pretty consistent levels of demand, not just quarter-to-quarter but even month-to-month. We’re just not seeing the variations and fluctuations that we had certainly during fiscal 2021. And back to flu, even with a little bit higher volume there, we don’t know if it’s just early volume or more volume at this point. So, it may not be much different for the full year. But the main point is, it’s a very mature set of generic products that go along with that, which usually means it’s a lower price point, lower margin points and so it’s not something I would expect to be material. The big opportunity is a few years ago when Tamiflu went generic the first time, right, like that was the really [indiscernible] Historical so even they’re true. Let’s spend a couple of minutes on your Specialty business because it’s smaller than your two peers. You talked about it today as a growth opportunity. So maybe start with how these services have changed over time? And hopefully, you have some historical perspective on how they’ve changed? And where do you think the future is going and how Cardinal will play a role in the future of that? Well, as I commented earlier, we have a very broad level of services that go along with our specialty business. And by the way, we are very large and very relevant. This is by far our largest growth area, and it has grown consistently at double digits over the last several years. So, it’s a space that we are very relevant, and we continue to see the same type of opportunities in front of us and to ensure that we continue to evolve and provide the most relevant services to our customers, that’s where we’re making both the organic as well as the inorganic investments, whether it’s the technology. Even the restructuring that I talked about that, that was very much focused on ensuring that the Specialty business, the distribution and the upstream have the right leadership, resources in place to drive that, given the importance of that on our organization. And again, back to our inorganic types of opportunities, this is an area that is -- M&A is, in general, for Cardinal Health is not the highest priority of capital deployment, but within M&A, one of the highest priorities for us would be the Specialty business. So, it’s an area we would definitely continue to look but there’s a lot of factors that would go into that. And I think you mentioned this in the presentation that Bendcare GPO acquisition, are there other opportunities like that in the market or was that more of a unique type of asset that was available? There -- the downstream side is completely crowded and has been consolidated some time ago. But on the upstream side, assets that are generally like Bendcare and there’s lots of other different services, too. So, I don’t want to talk about just GPOs, but in general, the upstream assets are much more fragmented, growing very quickly, tend to be good margin types of opportunities and so that’s where we would be most focused for inorganic. And so, when we think about beyond specialty, where you talked about growth, you’ve talked on other calls about other growth areas within Cardinal upstream opportunities. I think you’ve talked about nuclear coming back. So maybe can you give just a couple of minutes talking about maybe some of those other growth areas and the opportunities that you, see? Sure. Within the Pharma business, the largest by far would be nuclear. Now Outcomes is a great business and growing, but it’s relatively small. So, when you talk about what could move the needle over time, the Pharma business is still only -- it’s all relative to everything else, so only $1 billion top line business, but it’s a higher margin business. And as I mentioned in my comments, we are investing heavily into that with the Center for Theranostics advancement as well as other capacity in our ecosystem and other innovation. [Audio Gap] Which means that it takes a while for those investments to pay off, but when they do, it’s very predictable, and we have good confidence, which is why we can have a five-year plan and have confidence in committing to a doubling of that business over that five-year period through fiscal year 2026. On the medical side, the primary other growth business that I referenced is, of course, At-Home Solutions business that’s, again, also been growing very, very consistently, and we are also making investments here, not just in brick-and-mortar distribution capacity, which is needed because it’s a $2.5 billion business growing at 10% per year, it’s $250 million of product that’s got to get pushed through that pipe every year. So, we’re going to have some additional capacity there, but also in terms of some of the systems and processes that go along with that to ensure a good customer experience as well as an operational experience. We touched earlier on kind of destocking of PPE, et cetera. But I said some of your bigger products are going to be like surgical kits, et cetera. And so, we always get the question around how do we think about the current environment for elective surgeries? Again, I know you’re not reporting the December quarter, but how is it compared versus pre-COVID levels and do you feel like we’re finally back to kind of more normalization? Yes. It’s a little more clear to me on Pharma that we’re back to the pre-COVID. With medical, it’s even hard to define what pre-COVID is any longer. I mean we’re talking three years ago. But with Medical, it was I guess, early 2022, we had talked about -- well, fiscal 2021, the early part of that was when it was -- it went down faster than Pharma did, but then it came back pretty quickly. And it came back in the ballpark of where we were before. Always a little bit depressed. So we haven’t always gotten like all the way back, but we got nearly all the way back in and since then, the volumes have kind of bounced around a little bit. I’d say it’s a little bit more of a little bit of a lack of growth as opposed to having an actual reduction versus that pre-COVID. The key with utilization, though, is PPE. That’s the part that’s been most volatile. And again, there’s no new news here because these comments are very similar to what I said this last quarter, where it’s been much more predictable also for the medical business in the last couple of quarters. So that's why we feel certainly pleased with the underlying volatility in the business because both of our biggest businesses are showing that as we get farther and farther away from the depths of COVID, that those volumes are a lot more predictable. The managed care companies have talked a little bit about the acuity level, maybe being a little bit higher for surgeries. And again, they’re projecting for the next calendar year and they’re looking at this and saying, let’s say, you were supposed to have a new surgery and you didn’t do it. Did you pull an incremental ligament or something so that now it’s going to be a little longer surgery and a little more complex, so a higher cost. If that is the case that we see things that are a little more complex, not saying that there was pent-up demand, but more complex type surgeries, is that something that’s good for Cardinal? I really don’t know. I think I need to spend a little bit of time on that. That’s -- I think the key with our product line within Medical is it’s very diverse. And so as the tide rises and falls, that business will rise and fall with because we do have a very diverse across the surgical room, the recovery room. So I think that as there’s more activity, there’s more patients needing more procedures that will be a good thing for us, generally speaking. You’ve mentioned in the past the newly formed review committee, which you also talked about today, will present its findings and recommendations at the Investor Day in the first half of the calendar year of 2023. Any idea or you want to kind of maybe talk to us about in terms of focus and scope of those recommendations and what we might hear would be my first question? And then secondly, it’s been a while since Cardinal sent an Analyst Day. Anything else that we should really be thinking about going into that Analyst Day? So what I’ll tell you here is that we are already in the first half of the calendar year. So I would expect it by the end of the first half of the calendar year. So you can think about more on the June type of time frame is what we’re kind of penciled out at this point. And within that, I would expect it to be a fairly traditional type of Investor Day. We’re going to talk about the business, the operations, the strategy and of course, there’s going to be a portfolio component with that, but that’s several months in front of us. And so we need some time to be able to scope that out a little bit further before I can go much deeper now. I look forward to it. So as we have about a minute left together here, we started this discussion with your fairly new to the role, but a year from now when we’re sitting here together, what do you hope that investors will appreciate about Cardinal that perhaps they don’t appreciate today? Well, a year from now, I think it’s something you have to talk about each of the different components of our business. I think the short answer is what I hope investors see is that they think back about what we said today, what we’ve been saying pretty consistently in the last couple of quarters, they see a continuation along that journey. And a year from now, when you think about the Medical Improvement Plan, we’re going to be pretty deep into that, and we’re going to have some very key data points. We share every quarter, our progress on the pricing initiatives. And when you think about being halfway through our fiscal 2024 at that point in time, we’re going to have most of those -- or a lot of those prices in place and may not be in the run rate yet, but there’s going to be a lot of data points there. You’re also going to see the growth of the growth businesses, whether it’s At-Home, within the Medical business or Specialty within the Pharma segment. But as it relates to Pharma, I think what I hope and expect we’ll all see is that will be another year into what is, I expect to be a pretty resilient predictable demand pattern. And while I think our industry and our Pharma business has that reputation to some extent, we’ve also been shocked a little bit here the last couple of several years and adding one more year to that, I think, just gives further weight that, that’s a fairly resilient business. And then finally, I’d expect you to have another year of credibility about our capital allocation. When we talk about responsible focus on that deployment, I think you’re going to continue to see that and that investors will say, yes, that’s what they said they do, and that’s what they did. It’s consistent with the philosophy. We’ll have to make adaptations along the way, but we think it will be very consistent with how we’ve laid out the plan.
EarningCall_1482
Good day and thank you for standing by and welcome to the First Quarter 2023 Franklin Covey 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, Derek Hatch, Corporate Controller. Please go ahead. Thank you. Hello, everyone. On behalf of Franklin Covey, I would like to wish everyone a Happy New Year and welcome everyone to our first quarter earnings call for fiscal 2023. Before we get to the good stuff, I’d like to remind everybody that this presentation contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based upon management’s current expectations and are subject to various risks and uncertainties, including, but not limited to, the ability of the company to stabilize and grow revenues; the acceptance of and renewal rates for our subscription offerings, including the All Access Pass and Leader in Me memberships; the duration and recovery from the COVID-19 pandemic; the ability of the company to hire productive sales professionals; general economic conditions; competition in the company’s targeted marketplace; market acceptance of new offerings or services and marketing strategies; changes in the company’s market share; changes in the size of the overall market for the company’s products; changes in the training and spending policies of the company’s clients; and other factors identified and discussed in the company’s most recent annual report on Form 10-K and other periodic reports filed with the Securities and Exchange Commission. Many of these conditions are beyond our control or influence, any one of which may cause future results to differ materially from the company’s current expectations, and there can be no assurance that the company’s actual future performance will meet management’s expectations. These forward-looking statements are based on management’s current expectations and we undertake no obligation to update or revise these forward-looking statements to reflect events or circumstances after the date of today’s presentation, except as required by law. With that out of the way, we would like to turn the time over to Mr. Paul Walker, our Chief Executive Officer. Paul? Thank you, Derek. Hello, everyone. Thanks so much for joining us today. And as Derek said, we want to wish you all a very Happy New Year. I am joined by Steve Young, our CFO; by Jen Colosimo, the President of our Enterprise Division; Sean Covey, President of our Education Division; and several other members of our executive team. We are also happy to have Bob Whitman, our Executive Chairman, with us today as well. We are really pleased that our results for the first quarter of fiscal ‘23 were strong and even stronger than expected. As you know, the ongoing strength of Franklin Covey’s performance is driven by five key factors and I thought I would just briefly highlight these and then dive into our results. First, we help organizations address mission-critical challenges and opportunities. These challenges and opportunities require collective action of large numbers of people. The second strength is we have organized our entire company around helping clients address these challenges. And our solutions, which combine best-in-class content, technology, coaching and measurement work, they really do work. And as a result, our lifetime customer value is significant and increasing. And the duration of our subscription contracts continues to extend, increasing both the durability and predictability of our revenue. The third strength is the strength of our subscription business, which is growing at more than 20% per year and is driving an overall increase in growth for the entire company. Overall, revenue growth has increased from the high single digits to the low double-digits and now into the low-teens and we expect this growth to continue into the mid-teens and in the high-teens in the coming years. Fourth, the strength of our subscription business model, with its high growth margins and declining SG&A as a percent of sales, is resulting in a significant flow-through of incremental growth in revenue to increases in adjusted EBITDA. And finally, the fifth strength is that we have significant headroom for growth and we are investing to take advantage of it. These investments include growing our sales force by more than net 30 last year and – which will grow by more than net 40 this year. And in addition, we are making investments in content, technology and in marketing. So thinking about those five strengths and how they are playing out, let’s talk for a minute here. I’d like to share with you how they did play out in the first quarter. And I’d like to start with headlines, beginning with those regarding our double-digit revenue growth in the quarter. As you can see shown in Slide 5, revenue growth for the first quarter of fiscal ‘23 was strong, increasing 13.2% to $69.4 million. In constant currency, our revenues grew an even more rapid 16.6% even after absorbing the impact of ongoing COVID-related lockdowns in China in the quarter and a slow return to post-COVID normalcy in Japan. Our revenue growth for the latest 12 months through this year’s first quarter was also exceptionally strong, with revenue growing 14.3% and growing 16.2% in constant currency. As significant as was our overall growth for the quarter and for the latest 12 months, our subscription and subscription services revenue growth was even stronger. As also shown on Slide 5, total subscription and subscription services revenue grew 21% in the first quarter and grew 26% in the latest 12-month period, with the All Access Pass subscription and subscription services revenue growing 20% in the first quarter and 26% for the latest 12 months and the Leader in Me subscription and subscription services revenue growing 24% in the first quarter and 25% in the latest 12-month period. The durability of our revenue also continues to increase and our visibility into future revenue growth continues to extend and expand. As also shown on Slide 5, our balance of deferred subscription revenue, billed and unbilled, increased 25% or $30.5 million in the first quarter compared to last year’s first quarter to $151.6 million. And finally, as shown in Slide 5, for the latest 12 months in our North American enterprise operations, the percent of our total All Access Pass invoiced revenue, represented by multiyear contracts of at least 2 years, increased to 62% at the end of the first quarter, up from 55% at the end of fiscal ‘22’s first quarter. Now to some headline profitability metrics. As shown in Slide 6, our gross margin percent in the first quarter remained very strong at 76%, an increase of 100 basis points compared to the 75% in last year’s first quarter and close to the 77.7% gross margin achieved in the first quarter of fiscal 2022. This reflects strong growth in education revenues and 25% growth in subscription services, both of which carry a somewhat lower gross margin percentage. Our latest 12 months gross margins were also very strong at 76.4%, reflecting the same strong growth in education and subscription services revenue. Operating SG&A as a percent of sales improved another 199 basis points to 59.5% in the first quarter compared to 61.5% in the first quarter of fiscal ‘22 and improved 296 basis points for the latest 12-month period to 60.3% compared to 63.2% in the same latest 12-month period last year. The incremental flow-through of our growth in revenue to growth in adjusted EBITDA in the first quarter was 19%. Just as a point, it would have been – it was 22% in constant currency, reflecting the combined impact of strong gross margins and declining operating SG&A as a percent of sales. And the flow-through of growth in revenue to growth in adjusted EBITDA was 28% for the latest 12-month period and would have been 30% in constant currency. As a result of this strong revenue growth, adjusted EBITDA grew 16% or $1.5 million in the quarter to $11.5 million and grew 28% or $9.6 million to $43.7 million in the latest 12-month period. In constant currency, adjusted EBITDA grew $2.3 million or 23% to $12.2 million in the first quarter and 34% or $11.6 million to $45.7 million for the latest 12 months. Our net cash provided by operating activities was $3 million in the first quarter compared to $10.2 million in the first quarter of fiscal ‘22, reflecting changes in net working capital. We expect our cash flows from operating activities to be strong in fiscal ‘23. We ended the first quarter with $73.2 million of liquidity, comprised of $58.2 million in cash and with our full $15 million revolving credit line undrawn. Our strong and increasing liquidity, this adds to Franklin Covey, to our operational – adds optionality to us as we continue to invest in our business, evaluate potential acquisition opportunities and continue to look for ways to further enhance shareholder value. We are pleased by our accelerating revenue growth and our growth in adjusted EBITDA and by the business’ continued momentum. We are pleased that with our first quarter revenue growth of 13.2% or 16.6% in constant currency and our latest 12-month revenue growth of 14.3% or 16.2% in constant currency gets us off to a very strong start for the year. And now with that, I’d like to turn some time over to Steve to dig a little bit deeper to these results. Okay. Thank you, Paul and it’s a pleasure to be with everyone. Happy New Year. As Paul expressed, we are really pleased with the combined ongoing strength of growth of our revenue, adjusted EBITDA and cash flow. And as Paul also noted, we are pleased to have achieved these strong results even after absorbing ongoing COVID-related impacts on our results in China and Japan and after absorbing a $2 million revenue decrease related to unfavorable foreign currency fluctuations. I’d now like to provide a little more detail on the factors underlying this strong performance, focusing on the results in three key areas of our company, specifically in our enterprise business in North America; and our enterprise business internationally, in both our direct offices and in our international licensee partner operations; and in our education business, almost all of which is in North America. First, as shown in Slide 7, results in our enterprise business in North America were very strong in the first quarter and in the last 12 months. Revenue in North America, which accounts for 73% of total Enterprise Division revenue, grew 16% in the quarter and 17% in the latest 12-month period. Subscription and subscription services revenue grew even more rapidly, increasing 19% in the first quarter and 24% in the latest 12 months. Our balance of deferred revenue, billed and unbilled, grew 25% compared to last year’s first quarter balance. And the percentage of North America’s All Access Pass invoiced revenue, represented by multiyear contracts, increased to 62% for the last 12 months ended this year’s first quarter, up from 55% for the same latest 12-month period last year. Second, as shown on Slide 8, revenue growth was very strong in our offices in UK, Ireland, Germany, Austria, Switzerland and Australia, countries, which together make up approximately 48% of total international sales and where All Access Pass makes up a substantial portion of those sales. Revenue in these offices grew 12% in the first quarter and grew 20% in the last 12 months. All Access Pass subscription and subscription services sales, which make up approximately 83% of total sales in these countries, grew even more rapidly, increasing 13% in the quarter and 35% in the last 12 months. In our offices in China and Japan, which account for approximately 52% of our total international sales, widespread COVID-related lockdowns in China over the past 15 months, which continued to persist throughout our first quarter, together with a very cautious and slow return to normalcy post-COVID in Japan and the negative impact of FX, impacted results in these two countries as revenue declined by 8% and 20% in the last 12-month period. Our strong overall company results were after absorbing these impacts. Also shown in Slide 8, our international licensee partner revenue increased 9% in the first quarter and 15% in the latest 12 months. Our licensee partners’ operations continue to strengthen despite the impact of FX and world economic conditions. Finally, as shown in Slide 9, the results of our education business, which accounts for approximately 24% of total company revenue, were also very strong, with education revenue growing 23% in the first quarter and 21% in the last 12 months; education subscription and subscription services revenue growing 24% in the first quarter and 25% in the latest 12 months; education’s balance of deferred subscription revenue growing 20% in the first quarter; and our year-over-year retention and Leader in Me schools remaining very high at approximately 90% for the last 12-month period. Thank you, Steve. Thanks for reviewing those results. Driving these strong results is the ongoing strength of our subscription business. As shown in Slide 10, our subscription and subscription services revenue grew 26% in the latest 12-month period and now accounts for 77% of total overall company sales. This growth has been driven by both the growth in our All Access Pass subscription business in our Enterprise Division and by our Leader in Me subscription business in our Education Division. Maybe just a couple of bullet points on each of these. First, as shown in Slide 11, in the Enterprise business, All Access Pass subscription and subscription services revenue grew from $13.7 million in 2016 to $144.5 million at the end of fiscal ‘22 and grew further to $151.1 million for the latest 12-month period through the first quarter of fiscal ‘23. Second, similarly, the Leader in Me subscription offering is driving strong growth in the Education Division, where Leader in Me subscription offerings growth has been so substantial that, for the latest 12-month period, it accounted for $60.2 million or 93% of Education’s total revenue. And Leader in Me subscription revenues continue to grow rapidly, increasing 24% in the first quarter and 25% for the latest 12-month period. Our subscription model is also driving significant increases in both the durability and predictability of current and future revenue. As shown in Slide 12, our balance of deferred subscription revenue, billed and unbilled, continues to grow significantly, increasing 25% or $30.2 million to $151.6 million at the end of the first quarter. And additional durability and predictability of our revenue is being created by the increasing percent of our All Access Pass contracts, which are multiyear. At the end of the first quarter, fully 62% of our total All Access Pass subscription invoiced amount was for multiple year periods, up from 55% for the same period last year. Importantly, our subscription business model has also resulted in a significant percentage of our growth in revenue flowing through to growth in profitability. With our subscription offering’s strong gross margins and declining operating SG&A as a percent of sales, a significant percentage of our accelerating growth in subscription revenue is flowing through to increases in adjusted EBITDA. As noted a few minutes ago, as a result, adjusted EBITDA grew 28% or $9.6 million in the latest 12-month period. Given the strength of our subscription business, as just described, its importance – it now accounts for more than 77% of total company sales and more than 100% of our growth in sales. And given that we expect subscription and subscription services to account for substantially all of our sales within the next few years, we thought it might be important and useful to first articulate what we view as three important and differentiated elements of our subscription business model; and second, discuss the key factors that are driving them. I’d like to just briefly discuss these two points. As indicated in Slide 13, our business model includes three key and differentiated elements. These are as follows. First, when we enter into an All Access Pass subscription with a client, that contract becomes an asset worth hundreds of thousands of dollars; second, that the duration and certainty of these contracts is increasing each year, further increasing their value; and third, that our cost of acquiring a new client contract is not only significantly less than the net present value of that contract’s lifetime customer value, but it’s even less than the contract’s first year value. I’d like to briefly touch on each of these factors and what’s driving them. So first, when we enter into an All Access Pass subscription with a client, that contract ultimately becomes an asset worth hundreds of thousands of dollars. The average new All Access Pass contract has an initial year subscription sales price of approximately $27,000, which by the way, that amount has increased substantially from the approximately $18,000 average sales price when we first offered All Access Pass. In addition to the value of their All Access Pass contract, in the first year pass holder – as a pass holder, clients purchased approximately $13,000 in additional subscription services for an approximate total first year client spend of about $40,000, as you can see shown in the top node of Slide 14. As shown in Node 2 of that slide, the combination of this relatively large first year spend, our high logo retention rate, the fact that upon renewal, the average client significantly expands its All Access Pass holder population, and our clients’ significant and ongoing purchase of value-adding services to help them achieve their objectives, together means that the average annual All Access Pass client becomes – client spend becomes approximately $77,000. This significant average annual All Access Pass client spend not only more than offsets any revenue loss from contracts that don’t renew, but is almost double the first year spend of $40,000. Finally, as shown in Node 3, with a blended gross margin of approximately 85% on the $77,000 in annual revenue generated by the average All Access Pass contract, the average All Access Pass contract produces an annual contribution of more than $65,000. And with the annual revenue of the average All Access Pass contract continuing to increase each year, the expected lifetime value of an average All Access Pass contract is hundreds of thousands of dollars, an amount many times the value of the initial subscription contract. The second point underpinning our business – our subscription business model is that the increasing duration of our subscription contracts increases visibility into future revenues from those contracts and thus their value. As valuable as each All Access Pass subscription contract already is, the duration of these contracts and the increasing visibility into future revenues expected to come from them continues to increase their value. As shown on Slide 15, the percent of total invoiced amounts of All Access Pass contracts, which are for multiyear periods, continues to increase. As shown, in 2017, this percent was approximately 5. It increased to 37% in fiscal ‘19 to 53% in fiscal ‘21 and to 61% through the end of fiscal ‘22. As a result, the extent of visibility into future revenues, which will come from these contracts, continues to increase. As this occurs, we begin each new year with more billed and unbilled deferred revenue in place as a percent of the prior year’s total revenue. The extent of this increase can be seen on Slide 16. As shown, in fiscal 2017, the sum of billed and unbilled deferred revenue from All Access Pass contracts as a percent of the Enterprise Division’s prior year revenue was 30%. This increased to 40% in fiscal ‘19 to 59% in fiscal ‘21 and to 62% in fiscal ‘22. And as a higher and higher percentage of total contracted revenue becomes multiyear and as those contracts represent a higher and higher percent of prior year’s revenue, the certainty of our future revenue increases. This reduces the theoretical discount rate that should be applied to that future revenue, further increasing the total value of these contracts. The third point underpinning the subscription business model is as shown on Slide 17, our cost of selling or acquiring a new All Access Pass subscription contract, the cost of customer acquisition, or the CAC, is not only well less than the net present value of an All Access Pass’ – All Access Pass contract’s lifetime value, it’s even less than a client’s first year All Access Pass spend. Our direct sales force of approximately 300 client partners is large and growing significantly, so are our teams of implementation, strategists and client success professionals. We also invest in thought leadership, marketing, PR, etcetera, to help acquire new clients. However, we’re grateful that as a result of the effectiveness of our marketing, sales and customer success efforts, our relatively large initial contract size and our strong gross margin percent, our total customer acquisition cost, or CAC, is still less than the initial first year contribution generated by the average All Access Pass contract. This is important. Many organizations’ customer acquisition cost significantly exceeds the first year contribution generated by the average subscription contract. As a result, the more rapidly they grow, the greater is the aggregate negative contribution generated from this new revenue. Their business models are based on the expectation that if they can achieve good revenue retention, over time their cumulative contribution will eventually turn positive and they’ll recover their first year deficit. While a number of companies are able to cover their cost of customer acquisition within 2 or 3 years, we’re fortunate to be in the position of generating a positive contribution in the new All Access Pass contract’s first year and then having that contribution grow each year thereafter. This is really important. It provides us with the ability to simultaneously achieve growth in both revenue and profitability. Importantly, this profitability is not only relative to the All Access Pass contract’s lifetime customer spend, but to its first year value. The combination of these three factors: that our subscription contracts have a high and increasing lifetime customer value, that our average subscription contract also has an increasing duration, and that our cost of acquiring one of these extremely valuable contracts is a fraction of the contract’s total lifetime value and even less than the contract’s first year value provides us with a unique opportunity, the opportunity to generate accelerating revenue and while at the same time achieving accelerated growth in adjusted EBITDA. Three key factors underlying and are driving and enabling our strong – the strong business model, as shown on Slide 18, they are: first, the mission-critical nature of the kinds of challenges our clients engage with us to address; second, the effectiveness of those solutions and helping clients address the challenge – these challenges; and third, the strength and reach of our client-facing organization in acquiring, serving, retaining and expanding client relationships. I’d like to just share a thought or two about each of these. First, as shown on Slide 19, is the importance of the mission-critical challenges we help our clients address. As we’ve reviewed in some detail in prior quarters, and therefore, I won’t go into the same level of detail here today, the opportunities and challenges we help our clients address, challenges that, by definition, require the collective action of large numbers of people, are must-win for organizations and are long-lasting. These must-win challenges include things like executing on a major strategic objective, the accomplishment of which requires the collective focused efforts of large numbers of people; or building leaders at all levels, leaders who can both achieve their big business objectives and do so while leading in a way that engages their people and builds the organizational muscle necessary to achieve even bigger objectives in the future; or establishing a culture that builds trust with all key stakeholders. Because these kinds of challenges are always important, helping clients to successfully address them provides us with the opportunity to establish long-term partnerships with our clients and schools, partnerships that endure in both good times and in more challenging times. The second point I would highlight is, as shown on Slide 20, the effectiveness of our solutions in helping our clients successfully address these challenges. As we’ve noted in the past, and as shown on Slide 21, most organizations already have pockets or units in which their business results are exceptional. Trust is high and their leaders lead in a way, which unleashes the potential of their people. Every organization also has variability, often significant variability in the performance across its units. And this variability provides our clients with both a tough challenge and a big opportunity. As shown on Slide 22, our solutions combine best-in-class blockbuster content; technology, including our new impact platform, which allows us to deliver this content with impact and at scale; the guidance of extraordinarily talented and experienced people, including our world-class coaches and facilitators; and metrics that provide clients with the ability to measure the impact of our solutions in moving desired behaviors and results righter and tighter. And third, as shown on Slide 23, is the strength and reach of our client-facing organization in acquiring, serving and retaining and expanding these client relationships. We’ve organized our entire company around helping clients address exactly these kinds of challenges. And the combined efforts and capabilities of our thought leadership and marketing, our client partner or our salespeople, and implementation strategists and our coaches and consultants provides us with a unique capability to acquire, serve, retain and significantly expand client relationships. And our reach includes direct operations in nearly all of the world’s largest economies and an extraordinary licensee network, which is able to serve client needs in more than 150 countries and in almost every language. This creates a network effect that’s really hard to replicate. The combination of these factors is providing us with a unique set of capabilities with which to serve customers and a set of capabilities that translates into both strength in acquiring new clients and an extraordinary capability to serve, retain and expand those client relationships. And we’re working and investing continuously to further strengthen our already significant strategic strengths. As shown on Slide 24, by continuing to make significant annual investments in existing and new content areas, technology, which allows the delivery of that content with both high client impact and at significant scale and the size and capabilities of our sales force and the reach and impact of our thought leadership. We’re pleased that because of our strong business model, we’re able to make these ongoing investments to accelerate our growth in revenue, while, at the same time, accelerating our growth in adjusted EBITDA and cash flow. I want to express my huge appreciation to our amazing teams that are making this possible every day. I’d now like to turn some time over to Steve Young to review our guidance and our multiyear outlook. Thank you again, Paul. So guidance and outlook, as shown in Slide 25, 2 months ago in our year-end report, we provided full year FY ‘23 adjusted EBITDA guidance in constant currency of between $47 million and $49 million, which reflected an upward revision from the $47 million to $48.5 million we guided to in July. We are really pleased with the first quarter being ahead of our guidance and even in the context of the challenges in the broader world and economy, are pleased to be able to reaffirm our full year guidance of between $47 million and $49 million, and our outlook targets of $57 million in FY ‘24 and $67 million in FY ‘25. Underpinning this guidance are the following expectations. First, the significant amount of deferred revenue currently on our balance sheet will be recognized. This deferred subscription revenue is secure, it’s already been billed, and the majority of it has already been collected. In addition, a significant portion of our $74.9 million of unbilled deferred revenue will be billed in this year, and a portion of that will also be recognized during FY ‘23. This significant balance of deferred subscription revenue provides tremendous visibility into our revenue for FY ‘23 and beyond. Second, that in addition to the recognition of our deferred revenue, our All Access Pass and Leader in Me subscription and subscription services sale will continue to achieve strong growth, driven by high revenue retention, sales to new logos and expanding lifetime customer value. These are assumptions in which we have a high degree of confidence. Third, and due to the strength of our subscription business model, the ongoing investments we are making this year in sales force growth and in content and technology gives us confidence in our ability to accelerate our growth in years to come. We view this as an important time to make these investments because it gives us an opportunity to increase our share of market in this environment. We’re expecting sales in China and Japan to be relatively flat in the year, reflecting post-COVID impacts. Consistent with our overall guidance of adjusted EBITDA increasing from $42.2 million in FY ‘22 to the $47 million and $49 million that we’ve talked about in FY ‘23, we expect adjusted EBITDA in the second quarter to be between $8 million and $9 million. The $8 million in adjusted EBITDA we achieved last year was a good result, up 57% from the year before. We feel very good about achieving this result, particularly given the second quarter is one of our smallest revenue – is our smallest revenue quarter and that many of our growth investments, such as client partner hiring and investments in content and technology, are relatively evenly spaced throughout the year. We expect reported revenue growth in the second quarter to be approximately 11%, even after absorbing the approximately 200 basis point impact on growth of current foreign exchange rates and the expectation of flat sales in China and Japan. Excluding the impact of FX and of China and Japan, the rest of the business is expected to grow approximately 15% in the second quarter. While some quarters’ revenue will be higher than others, we expect revenue growth in the year to be approximately 12% to 13% in constant currency. While dramatic changes in the world, geopolitical environment, the economy and other factors could impact our expectations, these are our current targets. Thank you, Steve. We feel great about our continued momentum and are looking forward to continued accelerating growth. And with that, maybe let’s ask Victor to open the line up to questions, and we’d be happy to take those. Hi,guys. Thanks for taking my questions. Congrats on the Q1 and the strong start to fiscal ‘23. Just kind of starting at the top down. My first question is going to be regarding economy, inflation, the employment outlook in 2023, the risk of recession. And the reason I asked, and we’ve talked about this before, is the company is very different than it was during the last recession that we experienced. I guess two parts. One, are you seeing any impact from the economy, a slowing economy on new logos, for example, which, I would assume, would be a leading indicator? And then comments with regard to inflation and your pricing strategy for fiscal ‘23. Yes. Thanks, Alex. Great. Great question. So I’ll see if I can hit all three of those inflation, employment, recession etcetera. So first of all, just stepping back for a second, our clients are – unfortunately, because you’re a client of Franklin Covey, you’re any more immune to what’s going on in the world right now. And so our clients are dealing with the same thing. they are talking about where they are going to allocate their budgets, what the right size of their workforce should be going forward right now, all the things you would imagine that everybody is talking about and dealing with. So we certainly feel that. We’re in the middle of that. We hear that. We are – at many times, we’re partnering with them as they try to figure some of those very questions out. And so yes, to the extent, are we feeling some of those headwinds? We are. And don’t know what that necessarily looks like out into the future, but today, we’re selling into that environment, and we’re doing quite well in that environment and so just a couple of points of evidence there to maybe give a little bit of color to you. We just talked about the fact that we have 62% of our All Access Pass contract value is made up of multiyear contracts. I think that underscores the idea that we’re on these multiyear journeys with our clients, and there is a high level of commitment that they have to what they are trying to do and, therefore, also to us as their partner. We didn’t – we were in the environment in the first quarter and didn’t see a lot of those headwinds impact our first quarter results, as we just reported there. We’re on topics, as you know, that are important to our clients. I think that gives us a leg up there and helps us as well. We just ran some numbers yesterday actually and looked through the first 4 months of the year, how has attendance at marketing events, which is a leading indicator for us, has gone. And it’s up about 20% this year in the first 4 months over what it was in the first 4 months of last year, right? That’s a nice leading indicator. Our pipelines remain strong and full. So I think my answer to your question would be, certainly, we’re seeing it. We’re hearing it. To some degree, we’re feeling it. There are some sectors of the economy, some of which our technology clients aren’t expanding what they are doing with us at the moment. And then there are other sectors of the economy where we’re in large expansion discussions with clients. And so it’s a bit of a mixed bag there, depending on the client and where they are. But we’re navigating that, I think, pretty darn well right now. And I don’t know, based on what we see right now, we’ve tried to take all that into account as we’ve given the guidance that we’ve shared here today and reaffirming our guidance for the year. So that would be my answer. As far as the inflation question, we’re not susceptible really from a much – from a cost standpoint to inflationary pressures. We don’t have a big supply chain. For us, it would be in wage pressure. And we did see some of that last year during the Great Resignation, as many did, but that seems to have abated quite a bit this year. So Steve, I don’t know if you would add anything to that. And then related to that, I think, on the last conference call, you said that you do annual price increases after the end of the fiscal year. So on September 1, you implemented a price increase. And those typically range from 3% to 10%, with inflation running pretty hot right now, even though, hopefully, it might have peaked. What can you say about your price increase for fiscal ‘23? So we did implement a price increase at September 1, which is the beginning of our new – so we actually do it, Alex, for the fiscal year, not the calendar year. So we implemented the price increase September 1. And yes, over the years, we’ve taken it up between 3% and 10%. And this year, I would say, our weighted – we did take prices up 10%, but then we created an opportunity for our clients to experience less of a price increase than that if they were in exchange for a multiyear commitment, and we’ve done that every year as well. So we did do a price increase. And I would say, weighted average – with the number of contracts we have that are multiyear now, weighted average, we probably picked up 3%-ish or so from price increases. And then there are some that will pay 10% more, especially new clients this year, we did take the prices up. Got it. And maybe a little update on the Impact Platform. I know you tested it throughout last year, and you launched it in North America in October. How – what are the early indications from clients on that transition? Yes. Great question. Jen Colosimo, do you want to – you’re in the middle of that one every day. Do you want to talk about how our clients are feeling about the Impact Platform? Of course. Thanks, Alex. Just as we saw during the limited launch and during our pilot phases, what clients are most impressed with is their ability to scale. The administration being taken all into the Impact Platform, they are able to really roll out, which is a big challenge for limited departments, learning and development departments that have maybe less staff for the way we can actually scale so much of this in a differential way, which has been a challenge they have been facing for decades. And so we are having tremendous conversations of clients converting, taking cohorts through it, doing the one-on-one coaching, we are seeing great success with the technology we have rolled out. Great. And what are their next steps then? I think you also said in the last conference call, over the coming months, we will roll it out to the other countries and other languages and things like that. Where are we in that process? Our global rollout has begun with our English-speaking direct offices, meaning the UK and Ireland and Australia, have started the global rollout. And as we take the platform into a variety of other languages, we are anticipating an April rollout globally. Great. And then my last question, I will give other people a chance, is capital allocation. A full cash flow statement is not provided in the press release. Wondering if you repurchased any shares in the first quarter? How many share – what is remaining on the outstanding current authorization? And what are your plans for capital allocation in general, share repurchases, dividend consideration, both regular dividend and perhaps special dividend, I think people have talked about? Alex, we had about 800,000 buyback in the quarter, and that was related to the net exercise of long-term incentive plan shares. Our philosophy related to capital allocation is similar to what it’s been, where we are always looking at opportunistically buying back shares. We periodically talk about dividend, even though we are not in a position right now of pursuing that avenue. We also look at things related to acquisitions that we have talked about. So, basically, we are looking at all of those all the time, again, acquisitions, opportunistically buying back shares, maybe someday doing a dividend. And then we don’t mind having a little bit of cash on the balance sheet from time-to-time. So, we have about $20 million remaining on our authorization. And we talk about considering all of those capital allocation uses without making commitments because we are looking at those all time and opportunistically buying back shares. But I think I can say we will periodically be in the market buying back shares. Thank you. [Operator Instructions] The next question comes from the line of Nehal Chokshi from Northland Capital Markets. Your line is open. Alright. Thank you and congrats on a strong quarter here. Steve, how much of an incremental headwind or a tailwind was FX to the top line during the quarter relative to what you had expected a quarter ago? Well, it was a $2 million impact compared to prior year. So, it’s $2 million top line, $800,000 adjusted EBITDA impact. And we could see some of that coming, but that’s what the impact was. A quarter ago, let’s say – just one second. Our revenue impact, hold on just a second, we will give you an audit quality number. Two clicks away. I don’t remember exactly what it was. $1.4 million top line and the same $800,000 adjusted EBITDA impact. Okay. Great. Thank you. And Paul, so you mentioned that tech-related customers, and we see it in the headlines, a lot of layoffs, it sounds like it’s impacting, but they are not canceling contracts. Are they still going through the motions of doing renewals, especially those that are laying off employees, and it’s just simply you are not getting the level of expansion that you usually get? Can you just double-click there? Yes. I am glad you came back to that. Good question. So, a couple of things. One, and that’s not to say that there aren’t tech companies still doing business with us. In fact, the end of the first quarter, we closed a meaningful deal with a very, very large tech company who was very prominently in the news for laying-off a lot of people. And I think that highlights that even though you might let go 16,000 people, you still have 80,000 people left who need to be more effective, the culture needs to continue to make progress, etcetera, etcetera. So, my point there was, yes, so clients are still – we are still experiencing very nice renewal and retention rates like we have even in this environment. We had a nice new logo quarter in the first quarter. People are still coming to our marketing events, as I said. I was just more trying to highlight that it’s a bit spotty out there, and we do see some of those headwinds, and they show up a little bit more in some places in the economies than others. And there are other industries where we are talking about very large expansions right now. There is even a couple of tech companies that were talking about large expansions because, again, they are recognizing that business doesn’t end because we are facing headwinds. We still have to figure out how to get these important things done even in this environment. Something Alex said earlier, too, just to double-click back on that is, this is different for us. We had the subscription business model now, and we are much more entrenched with our clients, generally speaking, than we were pre-subscription, and we continue to see that be the case today. Okay. Great. And then service rates continue to attach – the service attach rates to All Access Pass continue to go up in this quarter, as it has been for – since the beginning of the pandemic. Can you just, since we are basically 3 years into that trend, go over reasons why this continues to increase? Yes. We had a really big subscription quarter in Q1, as you mentioned. I think a couple of factors that are driving this. One, we talked about the nature of the problems we are helping our clients solve. And by definition, these are the complex, thorny – we will use the word intractable problems. They have had them forever and they are not easy to solve and therefore, the idea that they are going to be able to solve them without help, that – they recognize that they can get further faster with experts. And we represent those experts, at least in the topics that we focus on. And so it’s very attractive to bring our people, and particularly when we are working with more senior leaders in an organization handling topics like strategy execution, sales performance, working on the level of trust that exists among senior leaders and organizations. It’s natural to have somebody come in from the outside and help facilitate through those topics. So, one driver of those All Access Pass subscription services and our Leader in Me services is that just the nature of the problems we are on lend themselves to let’s get somebody here to help us versus let’s have everybody sit at their computer and just kind of work on stuff on their own, right. You need to bring people together, and it’s nice to have an expert come in the room and help. The second thing that is driving services growth over the past few years, I think in this is that, in some ways, we are the beneficiaries a little bit of what happened during the pandemic. Pre-pandemic, we had the ability to deliver all of – almost all of our content live online like we do today. But back then, we pioneered the use of Adobe’s product, Adobe Connect. We put a new skin on it and we adapted all of our content for that. This was going back – we have had this capability for like 10 years, and nobody wanted it. I would say nobody wanted it, but 2% or 3% of our delivery was that way, and the other 97% or 98% was still people wanting to get together in a room with a facilitator. The pandemic hit and that was not possible any longer to get together in a room. And so we had that capability to convene people on Zoom or Microsoft Teams or WebEx or whatever technology you want, and there wasn’t an immediate pickup. In fact, if you tracked our results for a couple of quarters there, where our revenues declined largely because it was during that transition period where clients were trying to get comfortable with that live online as a viable delivery modality. Well, they did and we were there ready with that capability. And so today, we are dual threat. We are happy to come in and work with an intact team in person around the conference room table or in a conference room, and we are equally happy to get on Zoom and do this in 90-minute chunks. As it turns out, the 90-minute chunks spread out over time, three or four of those cobbled together over a few weeks provides a really nice segmented, spaced approach for learning to happen, and it actually is better for behavior change. And so what’s driven the services growth the last 3 years, I think is the nature of the problems and the fact that live online is a great way for the stuff that we do to be delivered. The impact is still very high. The net promoter scores are very high. And it’s – because it’s denoted in 90-minute chunks, it’s easier for clients to slot them into the seams of the work week or the workday. You don’t have to think about gearing up for, let’s go have an off-site. Everybody is going to leave for two days, have to come back and get caught up on work instead, hey, you need to be on from 1:00 to 2:30 every Wednesday for a few weeks, and we are going to work on this together. And so I think we are benefiting from some of the larger macro trends and changes, people becoming more comfortable with technology and the fact that we have had this great capability for a long time, and now we get to use it. Okay, great. And then given the robust results for the November quarter, and especially the 23% year-over-year increase in value of contracts signed for the November quarter, it seems to validate the thesis that Franklin Covey’s revenue will be resilient through recession. And then your anecdotal points about renewals despite layoffs, that all seems to line up really well, so why no-go to the guidance raise, basically? Why not address guidance range, yes. It’s – we have had a policy for a long time that coming out of the first quarter, we just don’t do that. Our fourth quarter tends to be – well, it doesn’t tend to be, it is – it’s very large. It’s when a lot happens in education, a lot of things come in there, a lot of our adjusted EBITDA for the year happens late in the year. And so our pattern has been to address guidance at the end of Q2 when we get a little bit closer to the back half of the year. And we intend to look at guidance again and address it in our Q2 call. Thank you. How is it going? Thank you for taking my call and congrats on the strong quarter. Just wondering if there is any catalyst for a turnaround that you all are keeping an eye out for in China and Japan? Just looking to – wonder when that might turn around? We are too. So, sorry, not to be – don’t mean to be – joke about that. But – so I think there are two different situations going on in China and Japan. First, I will start with Japan. Japan is, COVID has – like it has, largely in other places in the world, kind of run its course, come and gone. And what we are dealing with in Japan is just a slower than maybe even we would have expected return to normalcy there and expect that it will get back to where it was, but it’s going to be a slower climb back there than it has been in other parts of the world. What is a positive thing that may not be – it might not pick up immediately on in Japan, though is as – so, when we launched the All Access Pass 7 years ago in our English-speaking operations. We did not launch right away in China or Japan. Part of that was for language reasons and there were some other reasons as well. And so they were later to the game. As Japan’s business have gone through COVID, coming back out the other side, the team there is now selling, substantially all of their business is being converted to All Access Pass business. So, that does actually mute a little bit their return because the stuff they are selling is being put out on the balance sheet, right. And so their business is rapidly becoming All Access Pass over the next couple of years. We believe that their All Access Pass as a percentage of their overall revenues will mirror that of what we are seeing in the U.S. and our English-speaking operations around the world. And so that actually puts a little bit of an increased drag on the business as they come out of COVID. But long-term, it’s a really good thing because they – we would expect that they would enjoy the same type of growth rates and retention rates and things like that, that we have in other parts of the world. So, that’s the story on Japan. It will come back there. It is coming back and it’s being muted a bit because as it comes back, it’s being converted to subscription. China is a different deal. China went into COVID first 3 years ago, we all know that. They got COVID – because of their no-COVID policy, they got COVID back under control pretty quickly. And our business, which was hit hard early on, came roaring back and was roughly back to pre-pandemic levels a couple of years ago. China went back into COVID 15 months or 18 months ago or so, and we have been dealing with that bumpiness and choppiness. It’s doubly difficult there right now, as you have probably seen in the headlines, as they have gone away from the no-COVID policy, and they basically have chosen to just let COVID kind of do its thing. Significant numbers of people are contracting COVID. At one point, our entire office in Beijing had COVID at the same time and without recovering from that. And so that’s happening all over the country right now. The death rate is quite high. And so that, I think you asked about when – I don’t know how to predict what that will look like, but I think it seems logical that, that will run its course over the next some number of months here, and then China ought to get back to some normalcy. And what we have to point to there is when they had a handle on COVID the first time around, our business rebounded quite quickly and with back up to pre-pandemic levels within just a couple of quarters. So, I don’t know if that will be the pattern this time, but China and Japan are two different places. We do expect that they will continue to return. I think China will be hard for a good part of this year and we have tried to account for that in our expectations. But I think China will be slow this year. Very helpful. Thank you. If I could sneak one more in. You mentioned on Slide 14 kind of the transition that a subscription client has gone from roughly $40,000 a year to $77,000 a year. Can you go into a little more detail of what that transformation looks like and specifically what gross margins look like for our client as they go from their first year to second year and third year in the contract? Yes. So, great question. So, as we mentioned, typically, a client – that $40,000 of first year spend is comprised of what they spend for the All Access Pass subscription itself and then what they spend on the subscription services, the training, the facilitation, the coaching that we do. And so in rough terms, it’s about $27,000 of that first year spend is on the subscription itself for some defined population. They are buying a seat, a number of All Access Pass seats and the average amount totals to about $27,000. And then roughly another $13,000 in that first year of those subscription services we talk about. And then what happens is, is they are now a client of ours and they get access to – not only do they maintain access to their original client partner that sold the pass, but they now have access to a role that we call implementation strategist. And that team together is now working to look for opportunities to expand that client relationship. And what you are seeing between the $40,000 first year spend and the average spend of $77,000 is just simply that – as those clients stay with us to mature, we are expanding to additional populations and then selling additional services as well. And all along the way, the blended gross margin on that business, the subscription and the services, is roughly 85%. So, it’s a function of these – of our land-and-expand model. And the good thing about our model, I think it’s a good thing, is that even in landing, we are landing a fairly sizable chunk. Where others land, it’s a credit card swipe for a couple of people, right, for a technology purchase. And then you are hoping to expand usage of something from a couple of people to something larger. We are landing much more significant initial populations than expanding from there. Thank you. And I am not showing any further questions in the queue. I would like to turn it back over to Paul for any closing remarks. Thank you, Victor. Well, again, Happy New Year, everyone. Thanks for joining us today. We appreciate your continued interest in the company and for working to understand our story as well, as you do and we are grateful to have been able to spend some time with you today. We are pleased with the results in Q1 and look forward to talking to you again towards the end of March. Have a good rest of your day.
EarningCall_1483
Good day and thank you for standing by. Welcome to the Inspirato Third Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. [Operator Instructions] Please be advised that today’s conference is being recorded. Yesterday afternoon we issued our press release announcing our third quarter results and posted an updated Investor Presentation both of which are available on the Investor Relations page of our Web site at investor.inspirato.com. Before we begin our formal remarks, we remind everyone that some of today's comments are forward-looking statements, including but not limited to our expectations of future operating results and financial position, guidance and growth prospects, our anticipated future expenses and investments, business strategy and plans and market growth, market position and potential market opportunities. These statements are based on assumptions and we assume no obligation to update them. Actual results could differ materially. We refer you to our SEC filings for a more detailed discussion of additional risks. In addition, during the call, management will discuss non-GAAP measures, which are useful in evaluating the company's operating performance. These measures should not be considered in isolation or as a substitute for our financial results prepared in accordance with GAAP. Reconciliations of these measures to the most directly comparable GAAP measures are included in our earnings release. Thank you, Kyle, and good morning, everyone. On our previous calls, we have highlighted a number of new company records and expressed confidence in the ability to execute our short-term and long-term business plan, thanks to a resilient and growing subscription base of high net worth travel enthusiast. Today, in spite of rising interest rates and macro uncertainty, we continue to establish new company milestones. We are less than a month away from completing a year that will see approximately 45% revenue growth, and we are extremely confident in our multiyear outlook. We entered 2022 with several key objectives. First and foremost, with an emphasis on growing the supply of our residents and hotels to meet the demands of our growing subscriber base. Throughout the year, we have successfully demonstrated that this often identified key risk is very much an opportunity for Inspirato. As of September 30, we had 726 controlled accommodations, an increase of nearly 50% year-over-year, and 35% year-to-date. Importantly, we have strategically entered key markets in an effort to not only better serve our existing subscribers, but also to grow our presence for potential new subscribers. Our partnership with Canoe Place in the Hamptons is a perfect example of this approach. We also successfully increased our scale in existing high demand areas such as [indiscernible], Park City and Costa Rica. In terms of full year 2022 guidance, we now anticipate revenue of approximately $340 million and an adjusted EBITDA loss of approximately $35 million. These downward revisions are the product of a few contributing factors. First, a reallocation of internal sales and marketing resources to new and expanded target markets, business and philanthropy. Second, lower-than-anticipated Inspirato Pass subscription sales in the fourth quarter; and third, lower-than-expected fourth quarter total occupancy due to less than anticipated travel demand during the peak festive season. We are keeping a close eye on these trends and believe we have built in the appropriate level of risk into our 2023 guidance. In terms of reallocating internal resources, we believe there are a number of long-term benefits to increasing internal focus on Inspirato for Business and Inspirato for Good, including lower customer acquisition costs, stable and growing, recurring revenue and a strong pipeline of highly qualified prospects for our flagship club and past subscription offerings. We believe these new products will further diversify our revenue streams and significantly expand our universe of potential subscribers. In years past, investment in digital marketing served as the key driver of our subscription growth. Now with the early success of Inspirato for Business and Inspirato for Good, we have new marketing channels that are actually generating revenue, while simultaneously driving lead generation and ultimately new subscriber growth. In other words, we are beginning to be paid for something that has historically cost us money. This combination of increased revenue and reduced expenses as it relates to customer acquisition has the potential to meaningfully improve our LTV to CAC and should accelerate our path to profitability. As far as early results, Inspirato for Good, which was launched just 3 months ago, is off to a tremendous start. By year-end, we expect to have sold more than 500 subscription and trip packages, amounting to $1 million of incremental revenue, only a small portion of which is recognized in 2022 as it is split between subscription revenue over time and travel revenue at the time of trip. Equally important, our new Inspirato for Good subscribers have donated over a $1 million to charities of their choice. Last week we launched JauntLiving, a new extended stay offering that we believe will be a unique and differentiated benefit for our members. Our JauntLiving trip list features extended stays ranging from 2 weeks to 1 year and Select Inspirato accommodations with each reservation including the personalized service that is hallmark of travelling with Inspirato. As we head into 2023, our primary focus is on leveraging our existing infrastructure and the investments made throughout 2022 to improve our cost structure, both above and below the line. While we are well-positioned to opportunistically grow our supply in 2023, we're more focused on portfolio optimization than portfolio growth. In terms of additional cost savings, we are committed to being thoughtful regarding incremental investments, and anticipate our OpEx as a percent of revenue to materially improve over next year. Much of this projected improvement is attributable to the fundamental change in the Inspirato customer acquisition cost equation I just referenced. We are now prioritizing our stated goal of returning to positive adjusted EBITDA and expect to achieve greater than $400 million of revenue for full year 2023. Finally, I want to thank our talented and dedicated team for all of their hard work throughout the course of the year. 2022 has been a year of outstanding growth and change, highlighted by a number of tremendous accomplishments. We look forward to more of the same in 2023. Thanks, Brent. I'd like to echo your sentiment of thanks to the employees. There has been a lot of hard work throughout the year aimed at improving existing processes and implementing new ones, all of which has us very well-positioned for 2023 and beyond. Since going public earlier this year, we have invested in personnel in our financial and accounting groups. The restatements to our prior period balance sheets and income statements had no material impact on the company's results of operations, revenues, or operating cash flows for either of the impacted quarters. We are confident that the newly improved and implemented processes and procedures will ensure more timely accurate reporting moving forward. Moving to our third quarter results, we want to again deliver record setting results in multiple key aspects of our business, namely revenue, active subscriptions, total nights delivered and controlled accommodations. Total revenue for the quarter was $93 million, an increase of 44% year-over-year, and 11% sequentially. Our subscription revenue of $39 million represents an increase of $53 million compared to the third quarter of 2021, and it's primarily driven by the continued adoption of Inspirato Pass, which ended the period up 60% year-over-year at just over 3,800 subscriptions. Pass subscriptions now accounted for 24% of our total active subscriptions, which ended the quarter at approximately 16,300. This compares to 17% of total active subscriptions just a year ago. Travel revenue for the quarter of $55 million represents a 38% increase from the third quarter of 2021. In terms of the drivers of Travel revenue, we achieved 25% year-over-year growth in total nights delivered, a record 51,000 nights and 18% growth in our residence ADR to approximately $1,800 a night. Over the past year, we've delivered historically strong occupancy levels, albeit off from the peak of all peaks that we experienced in 2021 as well as strong ADR increases. Gross margin for the quarter was $30 million, or 32% of revenue, compared to $22 million or 35% of revenue in the third quarter of 2021. Similar to last quarter, our gross margin was impacted by the integration of new properties as onboarding, outfitting, staffing and the time needed to fill the booking calendar typically resulted in short-term margin compression. As Brent highlighted, we intend to shift our focus to portfolio optimization from portfolio expansion in 2023 and we anticipate delivering improved gross margins over time. This quarter, total operating expense as a percent of revenue improved to 43% compared to 48% a year ago and 49% in each of the first and second quarters of 2022. Moving forward, we look to leverage our increased scale as well as deliver on a renewed focus on costs to achieve positive adjusted EBITDA in the near-term. We had a net loss of $7.3 million and an adjusted EBITDA loss of $6.8 million compared to losses of $9.1 million and $4.1 million, respectively, in the third quarter of 2021. Shifting to the balance sheet, we exited the quarter with approximately $84 million of cash on hand. As we highlighted in the press release, we anticipate a year-end cash balance of approximately $80 million with no outstanding debt. Our team is excited for 2023 and ready to accomplish very clear and achievable goals aimed at driving long-term shareholder value. [Operator Instructions] Our first question comes from the line of Mike Grondahl with Northland Capital Markets. Your line is now open. Hey, guys. Thank you. My first question is really just, it sounds like you're increasing your focus on Inspirato for Business and Inspirato for Good, roughly about 1% of the [indiscernible] you have focused on those two areas. Thanks, Mike, this is Brent. It's a little bit in flux now as we see exactly how the market adopts to those two relatively new initiatives. Thus far, both of them have been going really well. As you can imagine, Inspirato for Business has a longer sales cycle, but larger transactions and Inspirato for Good, has a much shorter sales cycle, but smaller transactions. But I think if you put the two together, and we think about next year, I would say somewhere in the neighborhood of about a third, roughly, of the total sales force being allocated to those two new initiatives would be kind of a fair estimate. But we're watching them both optimistically as they are kind of outperforming our initial expectations. And we've kind of put some conservatism into the plan for next year as we think about what ultimately they will become as the year progresses and as we understand better ways to acquire those customers and more efficacy in our marketing, I could see those things changing over time. Got it. Yes, they sound pretty exciting. And then how are you marketing Jaunt for Living kind of the extended stay product, I think it could be characterized as? This is Brent again. Good question. I mean, the great part about having loyal subscribers and people who are paying money to be part of a platform where they're able to travel with the service and certainty of Inspirato is marketing is really nothing because we already have the job franchise that has worked really well for some of those have been going -- Jaunt has really been around for now about a decade. And so by putting JauntLiving in the Jaunt family, there's a [indiscernible] email that gets sent out at 1 o'clock Mountain Time and JauntLiving just becomes another version of that kind of members only way to be able to save. And we're also highly optimistic that JauntLiving will make a lot of sense and have great appeal for our base. Historically, because inventory had been so tight, we've actually not really allowed other than on very special occasions an Inspirato member to stay in one of our residences for longer than a couple of weeks. What we've now realized with post-pandemic, still a lot of work from anywhere and kind of the new normal of how people want to experience the world, particularly with residential accommodations. We have very high expectations for JauntLiving, and there's really no incremental cost or incremental marketing or incremental sales required for that opportunity. It's something that members have been delighted about the response has been very positive, essentially, universally positive. And it's a little bit of a considered purchase, right? People are going to take some time to think about where might they stay for a couple of months. But we have a team of people that are working with our members talking to them about the art of the possible for ways that they could experience our -- in our portfolio and kind of an opportunity they've never been able to do before. One other important part about JauntLiving is it also opens up a whole new avenue for us of inventory. There's a lot of inventory that is available throughout the world where there are short-term rental restrictions. So you're not even allowed to operate in certain jurisdictions without, for example, a 30 day length of stay and JauntLiving provides us an opportunity now to be able to participate in those markets where otherwise for example, we may not have been able to participate at all. So we're very excited about that new opportunity. Sure. Hey, Mike, this is Web. As you know, when we discussed in the past, retention is something that we monitor closely internally across all of our different product types. We haven't published numbers since the pandemic, wanting to get a full 12 months of stabilized sort of non-impacted numbers in order to have a clean baseline for analysis. So we're hopeful, Mike, that that'll be this year, it looks like it is and we're approaching the end of the year, and that we'll be able to sometime in the first quarter come out with some robust work to share with you in the market on retention for the full calendar year 2022. Hey, great. Thanks for taking my questions. Just circling back to your Pass subscribers, any -- can you touch on like the impact sort of the downturn in the equity market we've seen? How has that impacted sort of your sales pipeline in all your Pass and Club members and how that's impacting subscriptions? Sure. This is Brent. Great question. I think it's fair to say that the Pass product does the best when there's less uncertainty in the market. So Pass didn't do well during the pandemic, for obvious reasons, because Travel was somewhat impacted. Pass going into this kind of economic malaise that we're in right now with people not wanting to make longer term commitments, potentially not knowing about their job or not having as much certainty about their exact situation, we have seen some impacts as we disclosed in Q4, around Pass. Pass essentially is a different way of being able to [indiscernible] Inspirato inventory. And what you'll see and what you'll hear about over the coming quarters is that we've really now focused on this revenue stream that is going to be more durable and more sustainable over time, because it's more diversified. So if you think about our portfolio as a fixed expense with our operated residences, think about Pass being a channel and Club being a channel. And today, we're really talking about three new channels that are able to absorb that inventory, and continue to provide great RevPAR and great unit economics for Inspirato. So one of them would be JauntLiving, another would be Inspirato for Business, and another would be Inspirato for Good, all of those things have opportunities to complete and fill reservations in the portfolio. We do not expect Inspirato Pass to have the growth that it had in 2022 moving forward into 2023. That being said, we have diversified enough where we feel like we can still run the portfolio at a very, very good RevPAR, really focusing on our expenses at the field level as well. So you should be able to see greater gross margin as well as growth in the portfolio because we still have homes that have yet to be released into next year and absorbing all of that demand in a more diversified way really provides a lot more opportunity for us to maximize RevPAR, which essentially is the name of the game. Got it. That's very helpful. And then just on the next year's guidance I think you said $400 million in revenue for 2023. Is there any way you could provide like a breakdown on how we should be thinking between the difference between travel revenue and subscription revenue? Yes, Jed, this is Web. We haven't put out, of course, that level of granularity. I would say, given the base of revenue that we have in place and our subscriber count today being 8% or so higher than it was at the beginning of the year, we do think we'll be starting off at a more robust level of some embedded growth in that subscriber count. So I would look for that mix because of that [indiscernible], the mix between travel and subscription revenue to be roughly where it is now, that I wouldn't expect there to be material change. This is Brent. Another -- sorry, just one other component that's going to be quite important in the coming quarters, we're not prepared to talk about it today in detail, but a preview of coming attractions is interestingly Inspirato for Business and Inspirato for Good, both contain a combination of subscription revenue and [indiscernible] state revenue, because they come with bundled memberships as well as travel. So there's going to be a new component of subscription revenue that we'll be talking about in future quarters that is essentially a different type of subscription than our consumer subscription from Pass and Club, but subscription revenue nonetheless. And so we'll have some breakdown of how that works in future quarters as we start to get more sophisticated in that reporting for the plan next year. Got it. And then can you talk about sort of how you're approaching your supply roadmap into next year? I guess 80% occupancy is sort of that sweet spot that you've talked about? But how should we think about sort of -- how is the supply? I guess how is procuring the supply? How's that environment and just how should we think about your roadmap? It's something as you know that we focus on Jed, and we going back almost 2 years ago now, I guess, a solid 18 months, we have stood up dedicated infrastructure, and really sort of a muscular platform for acquiring new supply across our bread and butter, high net worth what we call retail channel as well as institutional and hotel channels. That -- that's the pipeline that we built. You saw it in our investor deck posted last night. We still have 70 contractually committed residences slated for delivery in the coming months and the coming year. So delivering on that pipeline, building it and delivering on has been a number one priority. I think in terms of targeting occupancy, you're right, historically, we ran before the pandemic, sort of in the 70s until [indiscernible] even lower at times. So getting up in the high 80s, what was running a little hot, somewhere around 80, seems to work really well. It strikes the right balance of being able to grow our supplies with new and diverse inventory, and being able to offer all of our subscribers a deep and broad and diverse set of travel alternatives. So I look forward to be around the same. You've seen the pipeline narrow a bit as we've been really selective, given the uncertainty Brent mentioned in the market. But we feel good about the capital markets actually unlocking supply opportunities to come our way. Hi, guys. Thanks for my question. Just, I guess can you help me frame the growth cadence for next year. You implied kind of 4Q guide is a pretty steep deceleration from this quarter. Should we expect kind of similar levels of growth kind of throughout next year? Or maybe [indiscernible] deceleration as we kind of progress throughout the year? I'm sorry just kind of looking for any, I guess help on how to model revenue for next year. There's going to be a pretty big deceleration on a year-over-year growth basis for the fourth quarter. Should we expect kind of on a sequential basis from that point on for revenue growth to kind of continue to decelerate into the end of next year? Or is there any seasonal factors that we should be aware of? Yes, That's a good question. So you're right. And look, we're forecasting a little shy of 20% growth for the year. We actually think given the environment we've been in, we felt pretty good about being able to broadcast that number while also delivering positive adjusted EBITDA. And in terms of the seasonality, the biggest thing we see there is it's not the question that was asked earlier, it's the mix by quarter between [indiscernible] subscription varies a lot. Subscription revenue, of course, by its nature is very steady and predictable. In the first quarter of the year, we typically see some of our highest travel volumes, both occupancy and rate. So that leverages into a lot of travel revenue growth. Then, of course, we saw it this last year, in the second quarter, we typically see a whole lot less travel, lower occupancy and lower rates. So I'd be focused, Brett, on sort of a mix between the two for each quarter, but hitting that overall growth target to get the $400 million, which is, like I said, a couple of points just below 20%. Got it. Understood. And then on the cost side of the business, you talked about portfolio optimization helping gross margin, what is the more immediate term impact of these actions versus the long-term? And I guess, should we be expecting gross margins to improve on a year-over-year basis in 2023? Yes, it's a good question. So you're right, we do highlight that during periods of significant operating portfolio growth, like we've been experiencing and delivered on that does impact margins to some degree, that sort of a natural expense and revenue mismatch when you're onboarding a significant volume of new properties. I think in terms of the year-over-year gross margin forecasts, that's not a level of detail we put out. I would highlight that we set it in our call remarks earlier, that 2021 peak of all peaks, and actually bled into the beginning of 2022, you saw in the first quarter, I think a record gross margin maybe in the history of the company in the first quarter of the year. So we're not modeling that. My hunch is that it'll be tough to top. That’s the way we think about that is the success and the growth of this business, both from investor perspective and from a subscriber perspective, was never predicated on 88% occupancy. The numbers that we deliver in the last year being in the 80s, we can deliver solid gross margins, and get to our long-term trajectory in the high 30s or low 40s on a percentage basis. Got it. Understood. And then your comment on the kind of operating expense reduction. Am I supposed to take that, or I guess are we just at a total operating expenses in 2023, will be less than or you just referring to as a percentage of sales, you would expect a decline? Yes, it's a good question. It's something we're really focused on. We have grown so much in the last two years now. And that's been really growing our infrastructure much of it has to do with going public. We foresee in our broadcasting that total dollar number will be less in 2023 than it was in 2022 obviously on a percentage basis as well. But the total dollars actually a reduction in or for corporate operating expense loss. [Indiscernible]. And on the Inspirato Select with Inspirato for Good and Inspirato for Business, you guys kind of briefly talked about I guess we'll get more on this in the coming quarters the kind of -- both the subscription and a -- the travel component embedded [indiscernible] in that model. How do you treat that from an ARR perspectives? It's just a subscription component included in ARR for this product? Yes, this is Brent. Like I said, we'll give a lot more color on this in the quarters to come because it's new to us as well. But in the example of both Inspirato for Business and Inspirato for Good, when a company for example, purchases reward travel for their employees as well as membership access for their employees, the revenue is actually split between recognized revenue when the travel is delivered, and subscription revenue over the period of the contract. And some of those contracts are a year, some of those contracts are 3 years. And so the subscription revenue would be not dissimilar to a SaaS model or a corporate subscription, for example, where at the end of term, you'd have to go and reup and resell the company when the term is over. Similarly, with Inspirato for Good, a bundle membership is included in the actual transaction that the purchaser is making. Just to back up a second, with Inspirato for Good, again, we're very excited about this in an example, where the donor pays, giving us illustratively, if they were to pay $4,000 at the -- at an actual nonprofit event, it would be very logical that 2,000 of that would go directly to the nonprofit. 2,000 of that would come to Inspirato. Of the 2,000, that comes to Inspirato, a percentage would go towards a 1 year subscription, and a percentage would be deferred in revenue until delivered when the travel actually takes place. So that's kind of the makeup of how that works. How we're going to report on it, and sort of what's the right word to segment our subscription revenue, kind of stay tuned until next quarter, but we're very optimistic that those are, first of all, expands our TAM massively. Those are two very, very large markets that we have not participated in, that allow us to have a different lens of the consumer on what it is that they're purchasing. And we also think that it gives us a long-term sustainable way of introducing more people to Inspirato who potentially might want to travel with Inspirato for different reasons. As one quick example, one of the large lead gen that we're getting for JauntLiving is actually coming from Inspirato for business. We have a particular very large financial services firm that is providing Inspirato to their Wealth Advisors, both for reward travel as well as membership, those people have a lot of flexibility, a lot of them are at the age in which they want to be living in other parts of the world. That's an example where we were able to do a transaction on Inspirato for Business, but it turned into not only an inexpensive lead flow for JauntLiving, but actually being paid for that lead to be able to come part of JauntLiving and be able to travel with us as well. So we're really trying to build more of an ecosystem and a platform where luxury travel is in the middle [technical difficulty] philanthropy, individual pay as you go, Pass, Select, different ways to be able to consume our fantastic portfolio, all of which is a way of saying we're making the TAM larger. Got it. Thank you. That was a lot. Maybe if I just ask one last question, you know, I guess end the year at like $80 million in cash. This quarter it was, I think that the largest kind of cash burn that you guys had, which seems pretty, I guess a result of deferred revenue and working cap. Is this -- would you expect this to kind of be the bottom in terms of free cash flow burn? And going into year should we expect kind of free cash flow to be closer to positive or breakeven? Yes, Brett, this is Web. I think historically in this year, again, was the case that yes, the third quarter is typically the largest, the cash in which the quarter in which we consume the largest amount of cash. We [indiscernible] logistical reality, we deliver a whole lot of travel in the third quarter, and we don't have any significant booking events or booking demands. I mean, people are on the beach in August on vacation, not booking the next vacation. So that's a typical seasonal dynamic that we've seen through our history. We do expect that that quarter will be the largest quarters up the bottom of the trough as you said in terms of consumption of cash. Hi, this is Jim [indiscernible]. Thanks for taking the question. So I guess first on the accounting issue that resulted in the delayed filing. Can you talk a little bit about your internal controls and kind of what can be done to prevent this going forward? Yes, as I said in my remarks, Jim, it's been a focus of ours in terms of staffing up and adding to the team, as we've made the transition to being public. We have Brent on a -- for the first time ever has brought out a head of internal audit that is tasked with delivering on the type of control environment that you would expect with the public company of our light kind of character. So we were confident that some of the initial steps we've taken, and that the medium term plan of putting that control environment in place that we won't experience any additional issues. We were, of course, noted in my remarks that the issues found didn't affect revenue, and they weren't material in any sense to the operating results of that business. But look, we're focused on getting that control on our place. And that's why we brought on the new headcount to ensure that gets done in a timely and [indiscernible] passion. Great. And then I guess, just on the portfolio optimization, is there an opportunity to sort of get maybe get rid of properties that have less year round utilization? I know we've talked, you guys talk to certain properties being better in that respect, based on the geography. Yes, a big part of our margin optimization over time, we'll be doing exactly that and fine tuning the mix of properties. different geographies operate at dramatically different margins, sort of logical when you think through it, you highlighted the calendar availability that is part of it. So we will -- we are and will continue to prune the portfolio, both for customer satisfaction and also for margin. Hi. Thank you for taking my question. I'm asking questions were [indiscernible]. Wondering how do you plan to reach positive EBITDA in 2023 if macro versus like, what does focusing on portfolio optimization mean like? Any elaboration on that will be appreciated? Sure. Hey, Jocelyn, its Web. I think that the couple levers that I point to are one and I made references earlier, we already have pretty meaningful embedded growth, both in a larger subscriber count, paying subscribers, now we're sort of starting off the year at a higher number. And then on the other side, we have significant visibility into our forward looking calendar. And we look at that and see a fairly robust level of booking activity at really high rates higher than we would have otherwise forecast. So the combination of those two, combined with what was referenced earlier around, not only containing corporate operating expenses, but actually delivering a net dollar reduction in corporate operating expenses for the year. Those are the levers that will lead us down the path to delivering positive adjusted EBITDA. Thank you. And then I recently came across an article saying, I know you guys focus on luxury rental, but I saw some like, in general, vacation rental owners have seen some their bookings coming to a halt, probably because of the short right things apply as people look for additional income or for reasons like that. So just wondering if you're seeing data as low or anything you heard? Hey, this is Brent. It's -- a really good question. It's been such a strange, I would say, almost 3 years now, I think almost 3 years. Going kind of back to the pandemic, where everything just shut down. And then very slowly, people started to feel comfortable travelling, and again, I'll be it at much lower rates. Eventually, that just reached a peak, which was last Q1, maybe Q4 of '21, Q1 to '22, where there just was not enough supply. Everybody just wanted to travel. That kind of worked its way into maybe the very beginning of Q2. And then we have seen a difference in just overall travel demand. It's not been remarkable. It's not been something that's jarring. But we are seeing that, for sure. People have moved Pass revenge travel, there's a little bit of travel fatigue out there last year, there was some softness, for example, in our domestic portfolio in the summer, because everybody wanted to be in Europe, we're anticipating that this year that domestic is going to be coming back. And a lot of people got your Toronto members maybe out of their system. I think for us, it's very important to continually think about how fast is the portfolio growing. Last year, the operating portfolio grew 40%, last year, meaning 2022. That's just a tremendous amount of growth, that's a lot of houses that have to be on boarded turned on, calendars get turned on kind of late in the cycle. So somebody has to make a decision to go book, nice vacation, 2 weeks or a month in advance, that's going to be much more regulated in 2023, there's going to be a lot less inventory that's going to be opening. And much of that inventory that's going to be opening in 2023 has actually already been released by Inspirato. So the combination of less growth, and more importantly, a more diversified, robust, and really a kind of more sustainable way of acquiring customers. That reaches a much larger tam allows us to be able to have confidence in this call at roughly 80% total occupancy number, because a lot more at bats are going to be coming our way through Inspirato for Business, Inspirato for Good and JauntLiving. Those are three plays that just were not in the playbook in 2022. And combining that with a lot less growth. On top of starting with a larger subscription base gives us confidence in our plan. All that being said, for sure, just out in the world, we are definitely seeing a difference in people will just travel and stay at home at any cost. I think those days are over and we have to work harder and be more creative and more innovative to build a portfolio and run and at profitability. Thank you. I guess my last question, just a small one, I guess just curious how many properties you have on your Web site or you having your inventory are exclusive to [indiscernible]. We have in terms of exclusive property. We put them in a couple of different buckets. Jocelyn, the biggest of which were what we're known for our exclusive residences. And I think we finished the quarter just over 500 I think the exact number is 509. So those are the ones that I'd point to as exclusive. We do have total control accommodations and more than 700. And the balance the additional 200 number of those are actually exclusive with respect to this specific unit. For instance, in the case of something on the premises of a five star luxury resort. But that gets into Shades of Grey around what we might define exclusivity. Wonderful. Thank you. Well appreciate everybody's thoughtful questions and listening to our story today. I want to wish everybody a happy holiday. And I think hopefully we'll be back out this next quarter. We'll talk to you then. Thank you.
EarningCall_1484
Greetings, ladies and gentlemen and welcome to the Truist Financial Corporation’s Fourth Quarter 2022 Earnings Conference Call. [Operator Instructions] As a reminder, this event is being recorded. It is now my pleasure to introduce your host, Mr. Ankur Vyas, Head of Investor Relations, Truist Financial Corporation. Please go ahead, sir. Thank you, Jess and good morning everyone. Welcome to Truist’s fourth quarter 2022 earnings call. With us today are our Chairman and CEO, Bill Rogers, and our CFO, Mike Maguire. During this morning’s call, they will discuss Truist’s fourth quarter results and share their perspectives on our continued activation of Truist’s purpose, current business conditions and our outlook for 2023. Clarke Starnes, our Vice Chair and Chief Risk Officer; Beau Cummins, our Vice Chair; and John Howard, our Chief Insurance Officer, are also in attendance and are available to participate in the Q&A portion of our call. The accompanying presentation as well as our earnings release and supplemental financial information are available on the Truist Investor Relations website, ir.truist.com. Our presentation today will include forward-looking statements and certain non-GAAP financial measures. Please review the disclosures on Slides 2 and 3 of the presentation regarding these statements and measures as well as the appendix for the appropriate reconciliations to GAAP. In addition, Truist is not responsible and does not edit nor guarantee the accuracy of our earnings teleconference transcripts provided by third-parties. The only authorized live and archived webcast are located on our website. Thanks, Ankur. Good morning, everybody and Happy New Year. Thank you for joining our call today. Truist delivered a strong finish to a pivotal and purposeful year. We completed our final integration and decommissioning activities and incurred the final set of merger-related costs. Adjusted PPNR grew a strong 12% sequentially, ahead of our guidance and helped us deliver on our commitment for positive operating leverage for the full year. We will cover the details on the quarter’s results throughout the presentation and we will start with our purpose, the foundation of our company on Slide 4. Truist is a purpose-driven company dedicated to inspiring and building better lives and communities. Our purpose is the foundation for our success as a company that drives performance and defines how we do business everyday. Slide 5 highlights many examples of how we activated our purpose in 2022. For our clients, our measurement is to provide distinctive, secure and successful experiences through touch and technology. We achieved a major milestone along that journey with the launch of Truist One Banking, our differentiated product suite that reimagines everyday banking and includes two new accounts that eliminate overdraft fees and provide greater access to credit. These accounts meaningfully advance financial inclusion in our communities and we are very encouraged by the positive reception they have received from new and existing clients alike. Based on August through December data, which reflects Truist One, branch checking production increased 10% from a year ago period and we achieved this result despite having around 400 fewer branches. The Truist One suite now also includes our new cash reserve deposit base credit line up to $750, which launched in mid-December and expands our commitment to our clients and communities. Our ability to innovate at the intersection of touch and technology was greatly enhanced by the opening of our new innovation and technology center, which brings our cross-functional teams together with clients and large tech companies to reimagine banking experiences for everyone. We have already realized the benefits of the ITC as Truist One Banking and the new digital and hybrid investment capabilities launched throughout the year were all co-created client with clients and our client journey rooms. We also continued to deliver on our mission for our teammates. In October, we took a bold step to improve the lives of our teammates by raising our minimum wage to $22 an hour. In the 3 months since this took effect, we have experienced improved teammate recruitment, retention, lower turnover expenses, better execution and an all-around better client experience. We also enhanced our total rewards program to include an employee stock purchase program to further align our teammates’ interest with those of our shareholders. As a company that champions diversity, equity and inclusion, we achieved our goal to increase ethnically diverse representation in senior leadership roles a year early with aspirations for further progress. Finally, Truist has made a significant impact on the communities we serve by meeting and in some categories, exceeding our $60 billion community benefits plan. Our first inspirational commitment is Truist and one that has served as a framework for similar plans across the industry. The execution of this plan was a testament to our purpose of building better lives and communities by elevating low and moderate income and minority communities through material support for affordable housing, non-profit, small business and community development lending. In summary, we are delivering on our purpose and the significance of what our teammates have accomplished is just outstanding. We will continue to raise the bar and I look forward to the year ahead as we actualize our purpose, advance integrated relationship management, positively impact clients and communities through continued investment in touch and technology and make Truist an even better place to work. Now turning to Slide 7, selected items for the quarter totaled $170 million pre-tax and included our final charges related to the MOE. Now that our integration activities are complete, MOE costs will exit our run-rate going forward. This is a positive development for shareholders that underscores our pivot to execution and will simplify our narrative, enhance earnings quality and improve capital generation. Turning to our fourth quarter performance highlights on Slide 8. Truist delivered strong fourth quarter earnings of $1.6 billion or $1.20 per share on a reported basis. Adjusted earnings totaled $1.7 billion or $1.30 per share, up 5% sequentially as strong PPNR growth was partially offset by higher provision expense. Adjusted ROTCE was 30% and even excluding AOCI, was 20%. Both data points are very strong. Net interest income grew 7% to $4 billion, a new high for Truist, supported by strong loan growth and significant margin expansion resulted from higher short-term rates and well-controlled deposit costs. Fee income rebounded 6%, primarily due to insurance seasonality of full quarter of benefit mall results and investment banking. Adjusted expenses increased sequentially, mostly as expected as the impacts of higher minimum wage, acquisitions and targeted investments were partially offset by the final leg of some of our cost saving efforts. Together, these factors drove a 12% increase in adjusted PPNR exceeding our guidance. This performance also resulted in 370 basis points of adjusted operating leverage relative to the fourth quarter of 2021, our strongest operating leverage results for the year. Our adjusted efficiency ratio was 54.2%, our best quarterly performance at Truist thus far. Asset quality remains strong and the sequential increase in provision expense primarily reflects moderately slower economic assumptions. We also deployed 10 basis points of capital as a result of strong organic loan growth and the BankDirect acquisition. Our capital position remains strong relative to our risk and profitability profile and we remain confident in our ability to withstand and outperform in a range of economic scenarios. Turning to our full year highlights on Slide 9. GAAP EPS was relatively stable year-over-year as significantly lower merger-related costs were offset by higher and more normal provision levels. Adjusted EPS declined 10% year-over-year, a solid 4.4% adjusted PPNR growth, was more than offset by the $1.6 billion increase in the loan loss provision expense. Importantly, however, we delivered 60 basis points of adjusted and 680 basis points of GAAP operating leverage for the full year, which was a primary metric to which we hold ourselves accountable to in 2022. This was our first year of operating leverage as Truist and it establishes a firm foundation, from which we can accelerate as we head into 2023. Turning to Slide 10, digital engagement rose steadily through 2022 as a result of changing client preferences and our improved agility as Truist. We experienced strong growth in digital transactions and Zelle, in particular, as transaction volume increased 42% since the beginning of the year. Zelle continues to represent an increasing percentage of our overall transaction mix and highlights the importance of continuing to invest in money movement capabilities. Our agility and responsiveness have improved tremendously since we have migrated to one digital platform built in the cloud, resulting in better client experiences. We delivered 3x as many production releases across retail, business and wealth in 2022 as we did in 2021. And as a result, our mobile app was rated at an average of 4.7 stars on Android and iOS at year end, up materially from a year ago. We introduced many new digital capabilities and solutions to clients in 2022 from Truist One Banking, Truist Assist and expanded digital investment capabilities, some of which are highlighted on the right side of the slide. In 2023, our goal is to more fully activate those capabilities with our clients to improve acquisition, retention and reduce cost. In addition to enhance digital capabilities for our clients, our digital and technology team successfully completed the largest bank merger in 15 years, decommissioned three data centers, successfully piloted a new deposit product on a next-gen real-time cloud-based core, enhanced credit decisioning and underwriting across certain consumer lending platforms and upgraded our contact center technology stack and completed a 5G network and branch WiFi pilot program. We have a great digital and technology team and they have been battle tested and have demonstrated incredible agility in responding to client needs during the integration period while also keeping their eyes on the future. Turning to loans and leases on Slide 11, average loan balances increased a strong $11.3 billion or 3.6% sequentially, approximately 20% of which came from the BankDirect acquisition. The improved loan growth we have experienced in recent quarters reflects our shift to execution and Truist’s greater competitiveness for clients due to our size and capabilities as well as broader industry trends. C&I grew $7.2 billion or 4.7% overall and increased 3.2%, excluding BankDirect, as balances increased across most CIB industry verticals and product groups and CCB. As in recent quarters, growth continues to be strong within our Asset Finance Group as we continue to build that business with more talent, product capabilities and larger balance sheet. Macro trends such as supply chain management, infrastructure spending, inflation and choppy capital markets are also supporting growth here. CIB delivered growth across most industry verticals due to a combination of new client acquisition, uptiering our position with existing clients, acquisition activity and business-as-usual liquidity management. Commercial Community Bank C&I balances grew 3.7%, reflecting the strength of our markets and our team’s focus on execution. Residential mortgage balances increased $3 billion or 5% sequentially due to previous correspondent channel production and lower prepayments. Excluding mortgage, consumer and card balances decreased on an end-of-period basis, primarily reflecting continued runoff in our student loan portfolio as well as our decision to pivot away from lower return portfolios such as prime auto. At the same time, we continue to invest in higher return consumer finance businesses, such as Service Finance, LightStream and Sheffield. Service Finance continues to grow and ended the year with over $3 billion worth of loans, ahead of high expectations at the time of the acquisition. Going forward, loan growth will moderate from the robust levels in 2022 as clients respond to the impact of higher rates, high inflation and a slowing economy. In addition, we also expect growth in residential mortgage and prime auto to continue to slow as we focus our capital on higher return opportunities. Truist remains well positioned to advise clients across a range of economic scenarios given our broad capability, talented teammates and increased capacity post-integration. Now turning to deposits on Slide 12. Average deposit balances decreased 1.6% sequentially as effects of tighter monetary policy, inflation and higher rate alternatives continue to weigh on balances. Deposit costs remained well controlled, reflecting the strength of our deposit franchise and our strategy to be attentive to client needs and relationships while maximizing value outside of rate paid. During the fourth quarter, interest-bearing deposit costs increased 52 basis points, contributing to a cumulative interest-bearing deposit beta of 27%, thus far. As the interest rate environment evolves, we will continue to take a balanced approach to maintaining and managing deposit growth and rate paid giving our broad access to alternative forms of funding. Our continued rollout of Truist One and ongoing investments in treasury and payments will be key areas of focus going forward as we look to acquire new and deepen existing relationships and maximize high-quality deposit growth. Great. Thank you, Bill and good morning everyone. I am going to begin on Slide 13. For the quarter, taxable equivalent net interest income rose a very strong 7% to $4 billion, primarily due to ongoing margin expansion and strong loan growth. Deposit costs were well controlled and reflect the strength of our deposit franchise. Purchase accounting accretion decreased $19 million and is expected to continue to gradually diminish. Reported net interest margin increased 13 basis points and core net interest margin improved 15 basis points as a result of higher short-term interest rates alongside well-controlled deposit costs. Overall, we maintain a balanced approach to managing interest rate risk, maintaining modest upside to higher short-term interest rates while having some downside protection when and if interest rates begin to decline. Looking to Slide 14, fee income rebounded during the quarter, increasing $125 million or 6% sequentially. The improvement was largely attributable to seasonality and insurance and the BenefitMall acquisition as well as higher investment banking and lending-related fee income. Insurance income increased $41 million, largely due to seasonality and a full quarter of BenefitMall results. Organic revenue for the full year grew 7% driven by a firm pricing environment, new business and strong retention. Investment banking and trading income increased $35 million as higher investment banking fees and strong core trading results in the quarter were partially offset by negative impacts from CVA/DVA. For the full year, investment banking income declined 37%, which we believe compares favorably to overall industry fee performance as the partnership between CIB and other lines of business continues to grow and earn momentum builds. Strategic hiring within CIB over the past 2 years has also led to improved lead table standards. Fee income declined 4% compared to a year ago, primarily driven by declines in market-sensitive businesses such as investment banking, wealth and mortgage and partially offset by organic and inorganic growth in insurance. Overdraft fees also declined from approximately $150 million in 4Q ‘21 to approximately $120 million in 4Q ‘22 as a result of the actions we took last year to eliminate a host of overdraft-related fees and the continued introduction of Truist One Banking to new existing clients. We expect overdraft fees to decline another 40% as we move from year end 2022 to year end 2024. While fee income remains below its potential, we are optimistic that our investments in key areas such as insurance, investment banking and wealth will payoff as markets normalize and our IRM execution continues to progress. Turning to Slide 15, reported non-interest expense increased $109 million or 3% sequentially. Merger and restructuring costs rose $18 million linked quarter and exceeded our October guide by $70 million due to higher-than-expected restructuring charges related to planned facility and branch reductions that will occur in 2023. These were business-as-usual decisions unrelated to the MOE and have solid financial returns. As Bill indicated, we will have no more restructuring charges or incremental operating expenses related to the MOE going forward. We would anticipate restructuring costs related to prior acquisition activity and other BAU expense normal rationalization efforts. It is difficult to forecast these with accuracy, but we would anticipate approximately $100 million to $125 million for 2023. Adjusted non-interest expense increased $68 million or 2% primarily due to the effects of our non-qualified plan. Excluding changes associated with the non-qualified plan, adjusted expense rose 0.6% sequentially, fairly consistent with our outlook from October. Personnel expense increased $84 million, half of which was from changes in the non-qualified plan and half of which was from the recent increase in our minimum wage. These increases were partially offset by a $35 million decrease in marketing expense and a $28 million reduction in other expense. The decline in other expense was driven by lower operational losses, which have decreased for two consecutive quarters, as recent investments in talent, technology, and process have begun to mitigate our fraud-related costs. Compared to the fourth quarter of 2021, adjusted non-interest expense grew by 8% as a result of the increase in minimum wage, investments in revenue-generating businesses, technology and acquisitions, higher call center staffing to support our clients post merger and a normalizing T&E spend. For the full year, adjusted expenses were $13.1 billion, up modestly from the $12.8 billion baseline in 2019. This performance is strong, reflecting the achievement of the $1.6 billion net cost save target. Overall, we continue to focus on generating expense reductions in certain areas to fund longer-term investments in talent and technology and to generate ongoing operating leverage. Below the line, our fourth quarter results also reflected an effective tax rate of 16.7%, down from 18.2% in the third quarter, primarily due to annual true-ups for state income tax returns. Moving to Slide 16. Asset quality is strong, reflecting our prudent risk culture and diverse loan portfolio. Net charge-offs increased 7 basis points to 34 basis points largely due to seasonality in indirect auto and lower recoveries. The allowance increased $172 million, reflecting strong loan growth and the ALLL ratio was stable at 1.34% as the effects of a moderately slower economic outlook were offset by high quality organic loan growth and the BankDirect acquisition. Excluding the BankDirect portfolio, which has extremely low losses through cycles, the ALLL ratio would have increased approximately 2 basis points. Continuing to Slide 17. Our CET1 ratio decreased from 9.1% to 9.0% as we deployed capital to support strong organic loan growth and close the BankDirect acquisition. We also continue to pay a strong dividend at $0.52 per share. Overall, our capital position remains strong relative to our risk and profitability profile. We expect organic capital generation to improve in 2023 due to the elimination of MOE-related costs and more focused loan growth, all of which will provide additional flexibility and opportunities for Truist. Finally, our liquidity position remains strong with an average LCR of 112% and access to multiple funding sources. Our securities portfolio remains high quality at 97% government guaranteed and continues to produce approximately $3 billion of cash flow per quarter, which has supported our loan growth. Turning to Slide 18 where I’ll provide guidance for the first quarter and full year 2023. Looking into 1Q ‘23, we expect revenues to decline 2% to 3% relative to 4Q 2022, primarily driven by 2 fewer days impacting net interest income in addition to typical seasonal patterns in investment banking, card and payments and service charges, amongst other factors. Adjusted expenses are anticipated to increase 1% to 2% as higher pension expense and FDIC premiums, along with seasonally higher personnel expenses are partially offset by ongoing cost discipline. For the full year 2023, we expect revenues to increase 7% to 9%, driven largely by strong net interest income growth and modestly improving fees. Adjusted expenses are anticipated to increase 5% to 7% as a result of higher pension expense, higher FDIC premiums, the full annual impact of our minimum wage increase and acquisitions that closed throughout 2022. These four factors drive about 4% of our year-over-year increase. Given these factors, we are targeting adjusted operating leverage to be 200 basis points or greater, which would be more than 3x our pace in 2022. We also expect the net charge-off ratio to be between 35 and 50 basis points in 2023, given our expectations for continued normalization across the loan portfolio. Lastly, excluding discrete items, we expect our effective tax rate will be approximately 19%, which translates to approximately 21% if you model it on a taxable equivalent basis. Great. Thanks Mike. Continuing on Slide 19, the fourth quarter was a strong finish to a year that was strategic and financial turning point for Truist. The pivot from integrating to operating is real, it’s palpable and it can be evidenced across a number of dimensions. Loan production in the fourth quarter was near the highest it’s been at Truist. This is despite some intentional reductions in certain consumer categories. Commercial Community Bank loan and deposit production in both the fourth quarter and full year was the strongest we’ve had at Truist. Importantly, left lead relationships within CCB were up 36% in 2022, reflecting our increased strategic relevance and advisory capabilities with clients. Branch deposit and checking unit production in the fourth quarter increased 24% and 8%, respectively, compared to the year-ago quarter as teammates became more confident with processes and systems, but also improved solutions and capabilities. Our wealth line of business has had three consecutive quarters of adding net new advisers, and organic asset flows continue to be positive. Integrated relationship management activity across the company gained momentum throughout the year as a result of more focus, increased alignment and improved reporting as we ended the year with a 16% increase in qualified referral activity, excluding mortgage relative to 2021. Average client satisfaction scores for retail and small business banking are ascending and in the fourth quarter reached their highest levels of for the year in key areas that include our branches, call centers, retail digital experiences and small business. Our digital app ratings ended the year as one of the leaders in our peer group after starting near the bottom. The financial benefits of this momentum can be seen with the fourth quarter operating leverage being the strongest of the year and adjusted PPNR building each quarter. So to conclude on Slide 20, our fourth quarter results reaffirm that Truist is on the right path, and I’m highly optimistic about our ability to realize our significant post-integration potential to summarize our investment thesis. Our goal financially has produced strong growth and profitability and to do so with less volatility than our peers. 2023 will be our first full year as Truist with zero integration activity, and our priorities are very clear: Core execution to actualize Truist and our purpose, harvesting IRM opportunities, continuing to digitize and automate our processes and operations and maintaining a strong profitability profile. We will also raise the bar on ourselves, focusing on the KPIs that drive total shareholder return and ensuring executive compensation targets reflects our potential, not just our business mix. While economic uncertainty remains high, Truist is in a position of strength across a broad range of outcomes because of our diverse business mix, conservative credit culture, balanced approach to interest rate risk management, strong profitability profile and our strong risk-adjusted capital position and most notably, our significant performance momentum as we continue to shift from integration to executional excellence and purposeful growth. Thanks, Bill. Jess, at this time, if you would explain how our listeners can participate in the Q&A session. [Operator Instructions] Thank you. [Operator Instructions] Our first question comes from Mike Mayo with Wells Fargo Securities. Your line is open. Please go ahead. Okay. Great. So it looks like – I’m going to push the Corvette analogy. It looks like you’re guiding for your Corvette of a franchise to go from first to second gear or maybe second or third, but you’re guiding for twice as much revenue growth. You’re guiding for 3x more operating leverage. But I and others are going to be unsure if you’re going to be able to get that given your headcount’s up 3% quarter-over-quarter in the fourth quarter, you have NII pressures from deposits, and you have capital market headwinds. So I guess the question is, what’s your degree of confidence with this 2023 guidance given some of the pressures and the internal expenses? And along with that, your merger saves, are they all in now? Or do you still get some payout effect that you benefit in the first quarter? I know you disconnected three data centers. Thanks. Yes. Yes, Mike, let me start with the last one first. Yes, they are all done. So we’re – excuse me, entering the year with positive aspect of not sort of having those adjustments every quarter to talk about. And then as it relates to the confidence in our guidance, there is a lot of market uncertainty. So we have to accept that. I mean there is – things could change the inflation, what are clients going to be doing, but we know a lot of our own internal momentum. We talked about – I mean, your analogy of first, second or third or fourth. I don’t know how any gears a Corvette has, but we continue to grind through that. So we have our own momentum that we’re creating. And you saw that in some of the production numbers. I think you see that in some of the deposit betas. You see that in terms of our ability to, I think, outperform both in the asset and liability performance of our company as well as in the stability of some of the fee businesses. We’ve got a great insurance business. We’ve got great momentum within our investment banking business. It isn’t just market-driven. I mean these are also relationships that we’re developing with our commercial core businesses. So we’re expanding our capabilities and our prowess. So while there are headwinds and we accept those and understand those, we have enough of our own tailwinds. I sort of call it, the Truist tailwind. That’s just our increased performance, our increased capacity. And when offset those Mike, that’s what gives me the confidence in the guidance is I can feel enough tailwinds to know that we can offset some of the headwinds that we may be facing. And then a follow-up, you mentioned good insurance, maybe this is for you, Bill and Mike. You have an insurance operation where publicly comparable peers trade at like 3x the valuation of Truist. So lot of press, no comment from you guys. All you did present involving about this business. How do you think about monetizing some of that unrealized value that tracks value so that shareholders might benefit more? Or is this just part of your firm forever and you would never consider a move like that? Yes, Mike, I mean, I think, one, I respect the question, but I think you’ve got to respect that as it relates to specific market rumors or speculation, I just can’t comment on that. But I can comment on the fact that we really like the insurance business. And we’ve been in the insurance business for a long time. Just celebrated its 100th year anniversary. So that was sort of cool. We’ve been supporting the insurance business from acquisitions. So they have been able to grow both, I think, very competitively from organic and inorganic basis, but it’s also a consolidating business. We want to make sure that we’re always providing the right level of support for that insurance business to continue to grow and continue to be really valuable contribution for our shareholders. Thanks. Good morning. Just wondering if you can provide us a little breakdown detail between – inside your revenue growth guide for the year, just generally speaking, what are you expecting for NII versus fees? And what rate curve are you using in your NII forecast? Ken, it’s Mike. I’ll take that one. I guess starting with the last question on the rate curve. Our outlook is that we will see two rate hikes in the first quarter, 25 a piece in February and March and see a policy rate stable until November, where we would expect a cut, which obviously, at the end of the year, probably doesn’t have much of an impact on our NII perspective. Breaking revenue for the year into two components. From an NII perspective, the way I’d think about it is we obviously had really strong growth in 2022. The second half, in particular, also had very nice margin expansion. So we have a really nice exit velocity from an NII perspective. We believe we have a little bit of asset sensitivity left. So we do have the opportunity to realize some of the upside of the hikes in the first quarter and we will have, as Bill mentioned, slowing loan growth. But those two factors combined, we think, give us a stable outlook for Q1 NII. And then for the rest of the year, that we believe we will stay relatively stable, some pressure on the NIMs offset by some modest amount of loan growth. On a year-over-year basis, just given the average loan growth that we would expect that will be, we think, a very nice growth. And frankly, we will drive the majority of the growth potential in the revenue guide. From a fee perspective, I think a couple of puts and a few takes. We expect to continue to have good performance from the insurance business, which is growing nicely on an organic basis as well as realizing the full benefit of the acquisitions that we completed in 2022. Our investment banking business, we believe, has some potential to benefit from improvements in market conditions, probably more likely in the second half than the first half. And then I think we will have a little bit of pressure. We would expect there to be pressure on the on the residential mortgage business as well as the service charges and overdraft fees on deposits. Okay. Great. And then a follow-up on deposits, 27% cumulative interest-bearing deposit beta through the fourth quarter. You guys were in the mid-30s last time. I don’t think yet you’ve given us an idea of what you think the cumulative could be this cycle, any views on that at this point in terms of the direction and the endpoint? Thank you. Yes, Ken. I’ll take that one again. Look, I’ve been very pleased by how the betas have performed so far. They have outperformed our expectations on a pretty consistent basis. We obviously are seeing some acceleration of rate pursuing behaviors and seeing pressures on balances as well, uncharted territory in many respects. We think we will get through the last cycle, perhaps even high 30s, approaching and even hitting 40% by the time we’re to the last hike. And again, it’s Bill. The only thing I’d add is just the strength of our deposit franchise. So you said I asked about our relative deposit beta performance. But we’re really experiencing what we hope we would experience as Truist. We’re sitting in great markets. We’ve got a 21% average share, our competitors’ mainly large banks. We’ve introduced some great new product capability in Truist One. Our branch production’s up. Our teammates are really doing a great job, the ubiquity of presence, the ability to amortize your marketing and be more effective. So our just strength of our overall deposit franchise is starting to manifest itself and show itself of what we thought we could create and create at Truist. Yes. Matt, our priorities remain the same in terms of the top four priorities. The first is to continue to invest in our business. And we’ve seen a lot of opportunity to do that. I mean you’ve seen the asset growth in our business and RWA growth, and we feel really good about the opportunities to invest in that. The second is to have a secure and growing dividend base. That’s important to our – both our institutional and our retail shareholders. So that’s a critical. And then the third is M&A opportunities, inorganic opportunities. And you’ve seen we’ve been active. They have been – some have been smaller by nature, but we’ve seen opportunities to enhance our businesses mostly in the insurance business, but also on the technology side and some capability side and some talent side that we’ve added in those areas. And then the fourth is the – is share repurchase. And for us, that just hasn’t been as big a priority because we’ve done a lot in the first three of those priorities. And as it relates to target, I mean, we’ve been sort of careful to say we really – we like where we’re operating right now. So we think we have got the capacity to do the things we need to do. We think given our risk profile, given our stress adjusted risk profile, we think we’re in a really strong position from a capital perspective. But also, as Mike noted in his comments, we accrete. If you think about our earnings profile, but also the fact that our MOE expenses come off, we are sort of in a unique position to accrete capital. So, we will accrete about 25 basis points worth of capital. We have been using some of that for those first two, three priorities that we talked about. So, I think on balance, we will probably see capital increase, but we are comfortable that we have got enough capital to execute our strategies and support our businesses. Okay. And then so hypothetically, if you say won the lottery for $5 billion, what would you do with that capital? I don’t think you are going to change the organic growth. The dividend is kind of tapped by regulation, roughly, the last two buckets of M&A and buybacks. And if you walk into that $5 billion, what would you do with it? I don’t want to answer a hypothetical lottery question because we are not lottery ticket buyers. That’s not part of our strategy. I think we have got that’s really based on, can we support our businesses long-term. And can we provide the capital they need to grow. And we are going to use all of our strategies and all of our capabilities to ensure that we are supporting businesses and their growth. Yes. Hi. Good morning. I was wondering if you could give us some color on how you see credit unfolding for Truist this year and what you have baked into the charge-off guidance that you gave for this year? John, this is Clarke. I will take that one. As you saw, we had 34 basis points in losses in Q4. That reflected primarily seasonality – normal seasonality in our consumer segments and a little bit of normalization. And as Mike mentioned, we had lower recoveries in our wholesale areas. So, that’s what the delta was from Q3 to Q4. And then what we are seeing is the consumer segments are normalizing. And also just to remind you all that the whole industry has had anemic wholesale and CRE losses over the last couple of years. So, we are pretty similar to that. So therefore, we would expect losses to return towards the lower range of our long-term loss range of 40 basis points to 60 basis points as we go through ‘23, and it just depends upon how the economy performs. And that’s why you see that reflected in our guidance of 35 bps to 50 bps. Okay. Thanks Clarke and then for Mike. Mike, on the expense outlook for adjusted expense growth, mid-single digits, how much of that is kind of pulling through acquisitions you added at the end of last year? And how much of that is kind of core expense growth and investments? Thanks. Sure. In ‘23, I believe the annualized M&A impact is $127-or-so million. So, that’s about 1% of that growth. You recall in the guide, we talked about these four components that were – where we have quite a bit of visibility into and frankly, not much flexibility, and that’s the pension, the M&A impact, the annualized impact of minimum wage and the FDIC expense. And those components in the aggregate are about 4%. Hope that helps. I guess just one follow-up, Bill, on the capital allocation question. One, just given – I mean there is obviously a lot of speculation when you talk to investors around the insurance business. Like if you can talk to, given the multiple difference between insurance companies trading at 20x PE, do you still think it makes sense in terms of deploying capital to do more acquisitions on the insurance front as opposed to buying back stock? And on the other hand, I would love to hear how you would think about maybe moving away from that business, but giving up a very defensible revenue stream? Yes. Ebrahim, again, I am not going to comment on sort of where we are from a speculative standpoint, other than to say, we love the insurance business. We want the insurance business to grow. We have done, I am staring at John, probably 100 acquisitions over time. So, we have got a really good framework in assisting that business to grow. But as I mentioned in my earlier comments, it is a consolidated business. So, we want to make sure that we have got all the flexibility and capability to create capital and support all of our businesses and their growth. Got it. And I guess just taking a step back with the merger integration done, the cost behind you. Remind us in terms of like what we have not heard so far on the call is the scale benefits as we think about go forward in terms of picking up bigger deals on the lending side, on the fee revenue side? Just remind us some of the revenue synergies we should expect from the Truist franchise on a go-forward basis and why you can outperform just the peers within the market or within your asset size set? Yes. Great question. And one of them I talked about just a minute ago was the deposit franchise. So, the scale, and the ubiquity, and the size, and the prowess that we have in our markets, I think is a distinct advantage and you see that. The other component of that is the markets that we are in. So, not only is it scale, but at scale in the right places. So, we have markets that I think will sustain sort of any economic environment with higher beta to the upside and a lower beta to the downside, so, in markets where we have a lot of in-migration versus out-migration and business development and growth. So, that’s one component. You mentioned the capital markets side, and I have talked about the community bank, the prowess that we have seen there, 36% increase in left leads and those type things. That comes from scale. That comes from an ability to be more relevant to our clients, to have discussions with them that we weren’t having before, to be more strategic and to be in that left lead spot versus that right lead spot. And we all know the economics of that. I mean the economics are multiples of where you are in the spectrum. So, our relevance is not only related to our scale, but also related to our product and capabilities. We have tried to sort of put a number on that. And I would say sort of back-of-the-envelope kind of math, I mean it’s at least 10% of some of the growth that we have seen in our investment banking business, we could attribute to being more scale-oriented, again, not taking outsized positions, but taking positions that are on the left versus the right and the economics that come along with that. And then everything to do with all the operations and efficiency, so, everything to do with the base that we operate from. We just had more opportunity to create more efficiency. So, when we do something that has previously had tens of millions of dollars of impact. Today, it can have $50 million and $60 million of impact because you are doing it across a bigger base and a bigger capability. The ability to negotiate better contracts with our providers and our partners and we saw a lot of that in the merger. Our ability to go in and be more relevant and more important to them, get terms that we think better reflect that. Mike, what else am I forgetting in that list because it’s a long list, I mean it’s a great question and one we probably ought to talk more about. Yes. I think it’s been moving more relevant on capabilities, more relevant on size. You are seeing it in the results, whether it would be the ability to manage expenses. Absolutely. We will do that. We will go back to Gerard Cassidy with RBC. Your line is open. Please go ahead. Thank you. Good morning Bill and good morning Mike. Can you guys share with us, you have got some good guidance on the operating leverage for 2023 being, I think Mike, you said about 3x the level of what you achieved in 2022. But I noticed that in the third quarter and fourth quarters, the operating leverage was higher than what you are hoping to achieve in ‘23. Can you share with us why there seems to be some slowdown in that operating leverage relative to the fourth quarter or third quarters of 2022? Yes. Sure, Gerard. As we look into ‘23, I think a couple of factors. One, we – obviously, 2022 was a year where we had outsized, particularly in the second half, loan growth and net interest margin expansion, which obviously was a great tailwind on the revenue side. As we look into ‘23, we expect to continue to have nice growth from a year-over-year perspective, but we are expecting that NII trend to really stabilize. And frankly, we are going to begin to experience some pressure on the NIM side probably in the second quarter. From an expense perspective, we also mentioned, there are a few just structural expenses that are in the plan for ‘23 that when combined, add up to about 4% year-over-year change. We obviously intend to make investments beyond those four categories in our clients and our teammates and in other strategic investment priorities. But that structural expense growth is there. So, again, we feel good about that sort of 2% with upside operating leverage guide and feel good about our – frankly, our revenue guide as well. So, hopefully, that’s helpful to you. Good. No, I appreciate that. And then as a follow-up, many of you – or many of your peers and yourselves are obviously building up loan loss reserves. The outlooks that people are using, are calling for a weaker economy, but we don’t seem to be seeing that yet in any of the numbers. And if you look at the spreads in the high-yield market, they haven’t blown out. One of your competitors or peers, as they pointed out that the spreads in commercial loans still are pretty tight. So, I don’t know, Bill, when you talk to your customers, what are they seeing that maybe we might not see as much of a downturn as everybody is kind of forecasting right now later this year? Yes. I mean I think you pointed out, I mean the data are confusing. There is just no doubt about that. I mean you see some positives and you see some negatives. If you look at – just think about the last few days, retail sales were not really very strong, sort of a poor Christmas selling season. You have seen inflation being a bigger part of what people do, and supply chain seems to sort of be reconciling itself. So, I think it’s more of a perspective, just – there has to be a higher impact from higher inflation. And whether that’s reduced hiring from our clients, whether that’s reduced capital investment, and all those type things. And in fairness, it’s a little more prospective. So, when we talk to our clients and we look at our portfolios today, things are great. I mean as Clarke mentioned, our commercial portfolio looks fantastic. Our clients are in really good shape. But rents will come due, things will – payments will come due, things will change over time. So, I think it’s just a little more of trying to understand where the economy is puck’s going versus where it is today, because I think today, it actually looks pretty strong. Clarke, what would you add to that? Well, I would just say, to your point, Bill, clients’ balance sheets, their liquidity, their financial positions are very good going into this. Obviously, depending on what happens in the economy, the impact of the higher rates, input costs, all of these things, we are monitoring very closely with our clients. Gerard, we are looking at things like CRE and the term risk and things like office. So, I think we are just looking out what could be some of those impacts from the – if the economy does slow and obviously, that’s reflected in everyone’s provisioning models. But to your point, the actual performance to-date and the near-term outlook is still strong. Consumer side, I mean on the consumer side, it is normalizing and in some cases, normalized to where we are right now. So, you do start to see some of that. We have done a lot of work looking at sort of our lower-income borrowers and some of the challenges that they may be facing from inflation. Maybe they are not facing it today, but that’s starting to build as they start to withdraw a little more deposits. So, it is more of a prospective thing than a current thing and we are all trying to find the right calibration of where things might land. And we don’t want to undershoot that runway. I mean we want to be conservative. We want to be appropriate and think through all the risk that could exist in the portfolio. Hi. I just want to understand a little bit more. I know we touched in a couple of different ways, but you have got the revenue outlook for 2023, up 7% to 9%. And what I am hearing is loan growth slowing slightly from the 11% level you have now, but really not that much and that the fees – fee growth will be lower due to some of the things you have mentioned around mortgage. But that loan growth is likely to be a little bit above that adjusted revenue number with the pressure coming a little bit in fees and then also NIM pulling back in the back half of the year. Is that a fair summary? Yes. Betsy, I think I would say it maybe a little bit differently. And I think Mike was trying to make this point. I mean we are sort of – if you look at sort of NII for the fourth quarter, and we are assuming that sort of stable through the year. So, that’s the big driver. I mean if you think about what’s the big bus and the revenue guidance, it’s NII being stable. And that’s not loan growth at the kind of revenue numbers. I mean the loan growth is going to pull back a little bit. Some of that’s going to be intentional on our part. A lot of it’s going to be return-oriented, just making sure that we have got really, really great relevance with our clients. And in some cases, the fee business is we expect to be up. We expect insurance to be up. We expect it to continue in its sort of high-single digit organic growth. We still have some inorganic momentum from some of the acquisitions we have gotten. We expect investment banking to actually return and increase its revenue growth. That will probably be a little more back-end weighted in fairness, but as we see where markets come out. But the big driver is sort of the NII fourth quarter where we are and that moving forward on a stabilized basis. That’s the biggest driver. And I know in the press release, you talked a bit about having – managing your deposit costs well and tightly, etcetera. Can you give us a sense as to how you think about the trajectory of that line item as we go through ‘23? Yes. I will do it at a high level. I mean it will be – continue to be slightly down. So, I mean I think that’s – that trend will continue. I think on a relative basis, we are showing deposit betas that are more reflective of our opportunity. And as the costs continue to grow, I mean deposit betas will increase. Mike, I don’t know if you want to comment sort of specifically how we are thinking about that. Yes. We mentioned in an earlier question that we see betas increasing. Whether they reach the 40% level or not, we will see. I would say the other trend, Betsy, which is consistent with what others are expecting and what’s consistent with our expectation is we are still seeing a remixing from DDA and interest-bearing so that makes sense. And we are still well above where we were sort of pre-stimulus. We were in the high-20s, 28%, 29%. We peaked during the sort of height of stimulus in the 35.5%, 36%. We are back at like 34% right now and going to 33% and probably approaching 30% over time. And I think, Bill, you hit it right. I mean I think we are seeing some deposit balance pressure in the aggregate and we would expect that to continue in 2023, perhaps moderate a bit. Alright. Thanks Betsy. Jess, it looks like there is not anyone left in the queue, so that completes our earnings call. If you have any additional questions, please feel free to reach out to the Investor Relations team. Thank you all for your interest in Truist. We hope you have a great day. Jess, you can now disconnect the call. Thank you. Ladies and gentlemen that will conclude today’s call. We thank you for your participation. You may disconnect your line at this time.
EarningCall_1485
Good morning. My name is Lisa Gill, and I'm the healthcare services analyst with JPMorgan. It is with great pleasure this morning that we have with us Walgreens Boots Alliance. Presenting for Walgreens will be Roz Brewer, CEO. After Roz does her presentation, she's going to join myself and their CFO, James Kehoe, over here at the table for some Q&A. Thank you, Lisa. Hello, everyone. It looks like we still have a few people filing in, but we'll go ahead and get started. So welcome, and thank you, JPMorgan, for hosting us today. Before we start, I will note the harbor statements that are on Slide 2 here. But today, I'd like to spend just a few moments to recap our first quarter results. We're just leaving earnings last week, Thursday. But just to recap those earnings, we had a solid first quarter performance, and we offered incremental color on our second half of the growth drivers. And today, I'm going to focus on also the accelerated transformation we're having in healthcare right now. So this was a landmark quarter for us, and it really showed the build-out of our next growth engine. And it showed that we invested to support VillageMD's acquisition of Summit Health creating one of the leading independent provider groups in the country. At the same time, we are taking divisive and very clear action to unlock value and strengthen the company and simplifying the portfolio. Now we're taking the next steps in our journey. We have new efforts underway to accelerate our global risk opportunity. We are also building out our clinical trials business with our first two contracts signed. Our strategy is working, and we will be relentless in driving continued progress ahead. So our execution to date really reinforces our confidence in achieving our full year guidance for adjusted EPS of $4.45 to $4.65. And we have raised our sales guidance, and we have greater visibility toward the strong 8% to 10% core growth that underpins our results. We are quickly scaling U.S. Healthcare with a defined path to achieve profitability exiting this fiscal year. So our bold investments today are enabling our future growth as WBA is building a differentiated healthcare services business with best-in-class assets across the entire care continuum. So with that in mind, moving to Slide 4. We are making progress against each of our four strategic priorities that we introduced in October of '21 when we had our Investor Day and as demonstrated with our first quarter results announced on this past Thursday. Let me walk you through the recent highlights and while I'll show you how they contribute to each of these priorities. And you'll hear us talk about these priorities, not only in this quarter, but quarter after quarter, so that you can attach to the milestones that we've set for ourselves and understand just how important execution is to us at this company. So first, transform and align the core. U.S. and Boots UK retail comp sales were both strong in the first quarter, with the U.S., excluding tobacco, up over 2% on top of almost 12% last year and Boots up 9% on top of 16% last year. Turning to our second strategic priority. Our healthcare strategy is coming to life through all of our best-in-class assets, which drove a combined 38% pro forma sales growth in the quarter. The addition of Summit Health will further enhance our portfolio of leading assets. This growth is funded through actions we continue to take to better align our investment portfolio, marking our third strategic priority. In November and December, we unlocked $3 billion in after-tax cash proceeds from the sale of 19 million AmerisourceBergen shares. Lastly, we have a strong team that is fully aligned with our strategy, including a new structure for U.S. Retail Pharmacy and John Driscoll, leading our U.S. Healthcare. And I think he's here with us. He is -- there, he is in the room with me today. So as we move on to the next slide, let me talk to you a little bit about our guidance and our acceleration in growth. So WBA, we entered fiscal 2023 with good momentum, and we delivered a solid start to the year. With earnings on Thursday, we've reconfirmed our full year EPS guidance shown on Slide 5 here. Our projection for the number of COVID-19 vaccinations is unchanged and creates year-on-year headwind of 16% to 18%. Now excluding COVID and currencies, we continue to project core business growth of 8% to 10%. In terms of phasing, at the midpoint of our guidance, we see a balanced 50-50 cadence between the first half and the second half of the year. Our full year guidance requires second half EPS growth of around 30%. And we have very good visibility into the key drivers. So let me walk you through why we believe we can deliver this strong growth. There are a handful of factors that comprise the approximately 60-point delta from the first half decline to the expected strong second half growth outlined here on Slide 6. While COVID will remain a headwind in the second half of the year, we expect that it would be a lot lower with an impact that is less than 50% of what we saw in the first half of the year. This will boost growth by 11 to 12 percentage points versus the first half. So it's important to note the shift there. Consistent with prior guidance, we expect the segment to achieve positive adjusted EBITDA exiting the year. The overall segment will flip from being a headwind in the first half to a significant mid-teens EPS tailwind. Now moving to International. We expect to return to strong profit growth in the second quarter, moving past the adverse gross margin impact of NHS pharmacy funding and the expiration of temporary rental reductions received in the prior year. This segment has delivered a strong Christmas trading period, with comp sales growth of around 15% at Boots. We expect International to contribute an additional 5 percentage points in growth in the second half compared to the first half. We expect significant second half momentum in U.S. Retail Pharmacy. So we have a clear line of sight to favorable trends in reimbursement that led to a tailwind of $350 million in the second half of the year relative to the first half. This accounts for 12 to 14 percentage points of growth versus the first half. Finally, ongoing script volume recovery should drive accelerating growth into the balance of the year as we normalize store operations and then we implement marketing win-back initiatives and that equates to about 12 to 14 percentage points of growth. So the factors I've outlined add up to a swing in about 75 percentage points of EPS growth from the first half to the second half, driving our positive inflection. There are partial offsets from higher tax, increased interest expense and the impact of prior sales of ABC and that those shares bridge to the roughly 30% growth we expect in the second half. Our first quarter execution and the good visibility for these drivers across the board combine to give us confidence in our plans and that they are achievable. So now let's dive into the second strategic priority on Slide 7 because that's why we're all here is to talk about how our healthcare assets are helping us deliver across the care continuum. Our Retail Pharmacy business provides a foundation for our leading healthcare assets to deliver value across the full care continuum. We are able to unite our digital and physical models to guide consumers through the complex healthcare landscape. We're building the scale and the resources to help health plans and patients, improve outcomes and lower costs is only Walgreens can do. There are significant opportunities for synergies, allowing us to pursue value-based care and risk arrangements, which will demonstrate the value of an integrated approach. We are focused on expanding our risk business, supporting integrated care models and expanding our pharmacy value proposition, while driving operational efficiencies. Now as shown here in on Slide 8, we're making important strides across the U.S. Healthcare segment. We're executing our strategic vision that we set out just over a year ago. Our investments have been significant. We invested $3.5 billion to support VillageMD's acquisition of Summit Health. We recognize the critical importance of scale in value-based care delivery and the density in attractive markets. This highly strategic transaction expands VillageMD's addressable market with primary care, multi-specialty and urgent care and reinforces our approach across the care continuum. The deal was also immediately EPS accretive and accelerates profitability for U.S. Healthcare. Now Shields, our Shields Health Solutions and CareCentrix continue to perform well, which led to the accelerated acquisition of both entities. Shields closed on December 28, and CareCentrix is scheduled to close in the third quarter of fiscal '23. VillageMD is leading the way in value-based care for the country, with 393 clinics as of year-end, including 200 of those are co-located with Walgreens, achieving the calendar 2022 target. We also exceeded our goal for Health Corners within our stores with 112 now versus 100 we had expected by the end of December. So we're ahead of plan there. Finally, as we'll cover today, we're working to accelerate our global risk business. We have also signed our first two clinical trial contracts. So moving to Slide 9. While our existing portfolio of best-in-class healthcare assets supports a strong future outlook, the addition of Summit Health is transformational. It's creating one of the largest multi-payor integrated provider platforms in the U.S., delivering quality, affordable care for all patient populations regardless of insurance or payor type. Our investment to support VillageMD's acquisition enhances the value of our largest U.S. Healthcare business. These complementary capabilities extend our reach across the care continuum further expand the addressable market and position us well to capture the full potential of the integrated care model across existing and new markets. So Summit Health, they operate at scale in the attractive New York and New Jersey markets. So on a combined basis, VillageMD now has over 4,100 providers across 680 locations in 26 markets. Now if you combine that with roughly the 9,000 U.S. Walgreens stores, of which 75% are within 5 miles of every U.S. household, you can begin to see how powerful this combination is and how we can impact the healthcare continuum. The combination allows us to manage more of total health spend than an expanded scope of services under an integrated connected model. This leads to a more seamless patient journey and drives high-quality care, better patient health outcomes and lower costs. In addition to the strategic benefits, Summit Health drives attractive financial returns for WBA and catapults the U.S. Healthcare business to scale and profit as outlined on this slide here. We expect $0.07 to $0.11 of EPS contribution in fiscal '24 and increasing thereafter. Importantly, we expect Summit Health to accelerate the path to profitability for the segment by one year, one year earlier as we now anticipate exiting '23 with positive adjusted EBITDA. The enhanced visibility also gives us confidence to raise our 2025 sales and adjusted EBITDA goals for the U.S. Healthcare segment. Our new sales goal of $14.5 billion to $16 billion is over 30% higher than our October forecast when we came forward in our Investor Day in October '21, while we expect roughly $1.1 billion in adjusted EBITDA, up by approximately $500 million versus October. We believe there remains opportunity to continue to grow sales and margins as the business scales beyond 2025 based on a maturing clinic profile and a shift to risk managements and unlocking synergies and across all the businesses. So we see meaningful synergy opportunities over time. And I just want to take a moment with this slide that you have in front of you to further elaborate on the $150 million run rate expected to calendar in '27. This is driven by two factors: accelerating Summit Health's transition to risk and cost savings; VillageMD had 441,000 value-based lives as of the end of the first quarter. While Summit Health is largely a fee-for-service model today, the company has been on a path to greater adoption of value-based and risk models. Now VillageMD can speed up that journey, leveraging their expertise, operational capabilities in tech platform. These can drive incremental value across a number of areas, including improving clinical documentation accuracy, growing the number of attributed lives, accelerating negotiations with payors to enter into risk contracts and improving the MLR through better care coordination. Primary care physicians play a crucial role in managing population health. And under these risk models serving as a quarter back for patients' care, Summit Health really increases the number of PCPs at the combined entity by over 50%. So leveraging the integrated multi-specialty capabilities that we see here can lead to tighter clinical integration, which is really important and better management of downstream medical costs, and patients remain within the Summit Health network, bringing a strong continuum of care. There is significant potential to grow risk-based lives in Summit Health's core markets. For example, as of 2020, there were 1.6 million Medicare lives in New Jersey, with roughly 32% of those in Medicare Advantage plans. This is below the national MA penetration rate of 40% and points to a larger, longer-term opportunity as penetration rises over time. The transition to risk accounts for roughly 60% or $90 million of run rate synergy target. So moving on to the second bucket that you see here, cost savings. And the cost savings opportunities will account for the other 40% of the target or about $60 million. This includes optimizing teams, process improvements and automation as well as improving vendor costs by leveraging scale and consolidating shared vendors. While this is the smaller of the two pieces, it is likely to drive a larger portion of synergy realization in the early years. We also see additional opportunities that are not currently baked into the $150 million target that could drive additional upside in the outer years. So just briefly, there is a potential to unlock value by leveraging Summit Health's experience in evaluating and building multi-specialty practices, which wasn't really at the top of our funnel at the beginning of our arrangement. But it does give us the opportunity to export the integrated primary and specialty care model beyond the New Jersey and New York's markets and into existing VillageMD markets and new markets ahead. So in addition, there are roughly 750 Walgreens pharmacies across the New Jersey and New York area, providing an opportunity to generate incremental store traffic and deploy pharmacy services such as adherence programs and medication therapy management and develop integrated pharmacy and healthcare offerings across eligible VillageMD and Summit Health patients. So you can now begin to see how this comes together. So let's shift gears a little bit here and talk about our organic healthcare business outside of the acquisitions that we've made. We see a natural path forward to taking risk, leveraging our integrated capabilities to align economics with value creation with an opportunity to drive significant incremental sales and profit contribution to WBA over time. The value-based care market opportunity across all payment types is expected to nearly double over the next five years, reaching $2.8 trillion by 2027. We finished the first quarter with 2.9 million contracted lives in our Walgreens Health organic business, exceeding our goal of 2 million lives by the end of calendar year 2022. So we're ahead. Our existing Walgreens Health payor relationships have started with more traditional fee-for-service arrangements tied to care gap closures and clinical quality services, such as health risk assessments, blood pressure screening, A1C test and mammography care coordination. Performance and execution under these relationships have led to increasing discussions around moving up the risk continuum. Under risk agreements, we are able to leverage our integrated assets across the care continuum, including VillageMD, Summit Health and CareCentrix as well as our full suite of clinical capabilities with our core Walgreens business. So this will drive engagement, improve outcomes and lower overall health costs, and we have efforts underway to accelerate our aspirations and global risk, and I look forward to updating you ahead. Let me take you on a little journey of a woman named Flora. So Flora, she's a 71-year-old Medicare Advantage enrollee. She has multiple chronic conditions, including type 2 diabetes, high cholesterol, arthritis and depression and values our existing provider relationships, given her complex conditions, but has experienced poor care coordination in the past. Now many of us in this room can probably think about someone in our family that's probably facing a few of these things. But as part of a payor partnership, a Walgreens Health advisor from Flora's local pharmacy contacts her to discuss additional benefits now available through her plan, including an annual wellness visit, which can be completed in the convenience of her home. The visit is conducted by a licensed Village Medical at home practitioner, who spends time to listen to Flora, collects your health history and get biometrics and labs. The practitioner then works with Flora and her caregiver to create a personalized plan outlining health goals and recommended next steps. Following this initial visit, a Walgreens Health advisor is assigned to essentially serve as a quarterback of Flora's care. The health advisor reviews Flora's care plan and listens to understand Flora's motivations, barriers and support system she can lean on. The health advisor also helps Flora coordinate recommended screening opportunities and appointments, along with her provider visits. Despite her best efforts to follow the care plan, unforeseen adverse events can always happen. Let's say, Flora ends up in emergency room with COVID. She is diagnosed with acute bacterial pneumonia and admitted to the hospital for fluids, IV antibiotics and close monitoring. Following her three-day hospital stay, Flora has discharged from the hospital to her home. Prior to discharge, a CareCentrix nurse reaches out to walk her through her discharge instructions and her care plan and to help coordinate any additional post-acute needs, including follow-up appointments, prescriptions and special equipment. The CareCentrix nurse also provides ongoing support to keep Flora healthy and avoid being readmitted. During a routine visit to her Walgreens Pharmacy, the following month, Flora meets with her health advisor, who understands her situation, answers questions, provides the support to ensure Flora is staying on her health journey. This includes network alternatives for any specialist care that is needed. As you can see, Flora is a dedicated care team -- she has a dedicated care team that knows her, is accessible and understands and supports her needs, every step of her health journey. This is how our integrated portfolio can improve outcomes, reduce costs and improve the consumer experience and the engagement. Real-life example. So now let's discuss our last topic today on this slide, the build-out of our clinical trials business. So we launched that business last June to redefine the patient experience and increase access, diversity and patient retention and sponsor-led drug development research. Walgreens Healthcare portfolio supports the journey of a typical clinical trial's patient and our foundational investments in technology and data solutions and offer a strong point of differentiation. Nearly 80% of trials failed to meet their enrollment goals in the stated timeframes, contributing to billions of dollars in delays and increasing costs. And we can improve that metric by rapidly scaling three portfolio integrated patient-centric service lines. First, our insights-driven patient recruitment business enables better precision and speed in identification and recruitment of trial eligible patients. Our extensive foundation of pharmacy and patient authorized clinical data enables proactive match of diverse patient populations to trials with culturally competent outreach to engage and empower communities. And this reminds us all of the hesitation that many had during the time when it was so critical for us to deploy vaccinations across diverse communities. Second, hybrid trials administration enables convenient, accessible participation via flexible formats, including virtual in-store and at home. And this leads to reduced drop-off rates and also addresses barriers to clinical trial participation, particularly among underserved communities. Finally, real-world evidence and informatics enable pharma companies to realize better long-term therapeutic performance through an integrated evidence strategy. Our commercial strategy is well underway, and we've signed our first two contracts with the development of additional priority accounts. Our offering is resonating with many of the top pharma companies and active engagement with our team. So in closing here, I'm confident, first of all, let me tell you in our -- the future growth potential of this company. And we've enabled the work that we need to do through strong execution and making bold investments consistently. We're building a differentiated consumer-centric healthcare services organization, and we've been expanding the U.S. Healthcare business rapidly, and we're expected to grow to $15 billion in sales and over $1 billion in EBITDA by fiscal '25. Our vision is being carried out by an experienced team of leaders, bringing significant industry experience together. And having met or exceeded our '22 -- fiscal year '22 objectives, I feel confident. So we have a winning strategy. And when you think about this, we're doing this with our payor-agnostic model, and we're integrating capabilities across the care continuum. Thank you so much, Roz, for all that detail. And sitting in this seat and having followed Walgreens now for a number of years, you've made this pivot to healthcare fairly quickly and fairly deeply and the assets that you've acquired. So maybe can we just spend a couple of minutes talking about how you really view your competitive advantage in the marketplace versus some of the others? And then on the flip side, what do you think are some of the bigger risks as we think about the future of putting these businesses together? Sure. So the reason why I think we all feel so bullish about this is that we start with a very strong base. For what we do on the retail side of our business and the number of customers that we see every day in our stores, we have almost 9,000 stores, and we get the chance to see customers consistently. We have digital relationships with them. We have physical relationships with them. We know their treatment history in terms of what pharmaceuticals they've been taking. And so when you think about that, it's not too different than the consumerization where you need to have on the healthcare side. So I think we're credible. We've built some strong relationships there. And also too, we have in terms of the digital engagements that we have, we have close to almost 60 million digital engagements. And so that's where this all starts is how do we tie these relationships together. To the second part of your question is where do I see the risk in this is that I think, collectively, we all need to think about collectively, not just Walgreens alone and not what we're building, but how do we jointly reduce the cost of healthcare because that's what this is all about. Because when we get to that point, we also begin to deliver better care. And so we put care in the right places at the right cost to the patient. And I think that's the part we all have to be concerned about. And that's so much around value-based care, which we talked about for years. As we think about each of these different components of your business really brings something different to the table as they think about value-based care. So one of the things we've talked about for a long time is the opportunity in pharmacy. And that that's the most interaction you have with the patient, right? If you think about the trusted advisor and the pharmacist, now you've put together this clinic model with VillageMD bringing in primary care doctors, the specialists, et cetera. You talked a lot today about taking risk. So as I think about value-based care and I think about the different ways that Walgreens Boots Alliance can come at value-based care, maybe just kind of highlight some of the way you view it? Like I said, I think of it as pharmacy, I think of it taking on risk in the clinic setting, I think about bringing people to the home for CareCentrix, what are some of the other things that we should think about for value-based care? Yes. I think some of the other things we should think about is putting the patient in the position to take control of their health because either you're going to need an advocate for your health at any point in your life. And so I think the part of this is the data and analytics and then bringing the data together and putting the actual patient and their caregiver in the position to do that. So I think that's one piece around it. The other piece is how do we get the math to show the improvements, right? And I think that's an opportunity for us at WBA as to further grow our technology base. So that when it is time for us to think about, are we really reducing cost, how do we prove that in real life? And so I think that's one more thing that you'll see come from us as a stronger tech underpinning in what we need to do because I think that's really important because we have to be trusted and people need to see the data around that. Is that an incremental investment, James, that you'll need to make from a technology perspective? Or do you get that with these acquisitions? I think with these acquisitions, we get a lot -- what we have said on prior occasions, we still need to build out slightly on provider enablement and call it population health on the tech side. But we're not looking at anything more than $200 million to $500 million of an acquisition. If you talk about value-based care, Village already has 440,000 on value-based, of which 125 are fully delegated risk. Summit has actually started. They've already signed contracts on value-based care. They probably this year have 15,000. So they won't start from zero. The other part you could think about is we do intend to take risk at Walgreens Health overall entity, true master contracting. And what will happen over time is we will go to payors with a suite of assets and sign a master contract and sub-delegate the risk out to Village, it could be Summit, it could be independent primary care physicians, and it definitely will be CareCentrix, right? So we do intend to take risk at multiple levels and where we've built the capabilities internally. I think the first thing you'll hear from us will be Medicare Advantage. And it's -- we're talking about months, not years. And so as I think about that conversion from fee-for-service to risk and a lot of the companies that people have seen in the last few days have talked about cohort data because it takes time, as you know, with Village where you get to know the patient, the patient's needs. And over time, they become more profitable. Will there be a step down when we think about Summit because it's primarily fee-for-service today if you are shifting towards risk? Well, Summit already was on the trajectory to go from fee-for-service to value-based care. And what we are so excited about is that relationship between Village and the Summit team because Village has that expertise already. So we see an acceleration there and the large population that Summit already has under its management is I just think it's a strong connection there, and it's immediate. It's actually profit enhancing for Summit because right now, they're on fee-for-service, which means that out of the total profit pool, they're getting a relatively small amount of it. And the more they can shift patients, they've already got the relationship with the patient. It's signing a new contract, right, and dividing the returns between the parties. So this was built in their forecast on building it over time. So there will be no -- we won't be coming back and saying there's a huge investment required. And then if I think about VillageMD and the overlap with Summit today, right, there's not a lot of overlap. You've talked about taking maybe some of the learnings from Summit from a specialty perspective and being able to replicate that in the other markets where VillageMD is. What's your anticipation there around the time line to be able to do that? And again, as the analyst, I always have to ask about the dollars, James. Are there incremental investments that you'll have to make? Yes, I think we said it very clearly though, we didn't count on it in the return on investment or the EBITDA multiples. There will be incremental investment. And that's why I think this is something you measure in years. So I think you'll see it in two, three, five years. You won't see it in the first 18 months of the integration. I think the challenge right now is to bed in the company in Village’s. They're both similar sizes, and it's not going to be an easy integration. So they'll be very focused on operations. And then if I think about CityMD, which is part of Summit, and I think about traditionally your clinic strategy, right? And you don't have the clinic strategy that you had several years ago. Is there an opportunity to maybe bring some of that clinic strategy into your footprint of a Walgreens store? Yes. So we haven't fully explored that. One of the things about CityMD, it's really nice to have because one of the things we do like about WBA is being able to deliver localized healthcare. And if you've been to a CityMD in the New York area, they're instrumental, they especially during the COVID period, I mean it was a place to go. And so I think they deliver a high-quality immediate service, and it's something for us to further explore. But no plans on right now. Okay. Great. James, I know you feel like you probably have answered this question in so many different ways, but it's the one we just keep getting and that's around script growth. And I think that it was really helpful on the call for you to talk about 50% of the incremental script growth coming from market growth and adherence. And the other 50% coming from the win back as you rehire pharmacists. When we -- and it's again primarily back-end loaded towards the guidance that you've given us. I think the big question that we've received is just the level of visibility that you have around those scripts coming back. And I think the first quarter may be not lower than your expectation, but maybe lower than some of The Street's expectation? Yes. The -- our scripts actually came in higher than budget, but we got maybe less from the store opening and more from market growth. Looking forward, we were -- we've basically said that there's 30 million scripts that we have to capture from this, and 2/3 of that will come from the marketing programs. We haven't even switched on the marketing programs only selectively on a test basis. So as we roll into the second, third and fourth quarter, we've basically said we'll go from 2% script growth in the first quarter, probably closer to 3% in the second quarter. And then there is a big step-up as the marketing programs are in full flight. Effectively, today, we still have 2,400 stores with some restriction on ours. It's down from the peak of 3,100, but we're still not out of the -- out of it yet. But most is coming from the marketing program, not the store opening. And one of the things that we've talked a lot about has been respiratory illness, not just flu. We've been writing this tracker from tracking COVID vaccines, flu vaccines, flu trends, et cetera. And I was surprised to hear on the most recent call, you talk about pushing back maybe the next level of a booster from the more near term to -- I think you talked about in the third quarter. Can you maybe just talk one about the trends you've seen? Two, you just reported, you talked about how strong the flu was, right, at the beginning of December. Does that mean we won't have incremental respiratory benefits in the first quarter? Somebody pointed out to me yesterday that we've never had a double flu season in the United States. So we probably are past that. Well, we have to listen to a national conversation on that, and we try and follow the science. But this has been an extraordinary period, almost a tridemic when you put in the RSV in small children. We are waiting to understand what could happen with maybe another booster coming soon. And the other thing that we're keeping our eyes on is the fluidity coming from China, right? And so those are the factors that we monitor and try and predict and forecast as best we can. The one thing I can tell you is that we outperformed our vaccination delivery in the first quarter. We did 8.4 million vaccinations. And we'll just continue to be there when this happens. But we're keeping close contact with national regulations that are happening and outcomes. I have like 19 more questions, but we actually have 1 minute left. So Roz, I know that there's been a lot of change with Walgreens over the last several years. What do you think investors will better appreciate about Walgreens a year from now as we're sitting together at JPMorgan 2024? Yes. So my hope for this company and all my executive team is that you'll see great execution out of us. We have built a foundation on three very strong acquisitions. The Shields business, which really supports what we need to do in our specialty pharmacy, which is one of the fastest-growing areas in pharmacy. Our CareCentrix business, which is at home care and then the Village MD business. We have to integrate those and provide a -- we'll call it master contracting when you see us go to market as one. And I hope next year, when we're sitting here, you can see our go-to-market strategy in real life. And you'll see that this team is executing every day. We wake up every day to think about how do we serve this customer in a way that we outperform their expectations, right? And so when they begin to think about their healthcare needs, it's Walgreens for healthcare services as well as pharmacy. And Roz, the other part is the inflection point. I think people will look back in 12 months, and we will -- if we hit our goals, we'll have delivered two quarters of EPS growth of 30%. And we'll have issued guidance for a healthcare segment with, I think it's $10 billion to $11 billion of revenue with [$600 billion] of EBITDA. And I think it will be in a very different place in terms of the perception in the market.
EarningCall_1486
Good day, and welcome to the Universal Technical Institute's Fourth Quarter Fiscal 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, today's event is being recorded. Hello, and thank you for joining us. With me today are our CEO, Jerome Grant; and CFO, Troy Anderson. During the call today, we'll update you on our fourth quarter and fiscal year 2022 business highlights, financial results, and vision for the future. Then we will open the call for your questions. Before we begin, we want to remind everyone that today's call will contain forward-looking statements within the meaning of the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Please carefully review today's press release for additional information and important disclosures about forward-looking statements. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and many of which are outside our control. Our actual results and financial condition may differ materially from those indicated in the forward-looking statements. Therefore, you should not rely on any of these forward-looking statements. As a reminder, relevant factors that could cause actual results to differ materially from the forward-looking statements are listed in the press release and our SEC filings, and the section entitled Forward-Looking Statements in today's press release also applies to everything discussed during this conference call. During today's call, we will refer to adjusted net income or loss, adjusted EBITDA and adjusted free cash flow, which are non-GAAP financial measures. Adjusted net income or loss is net income or loss adjusted for items that affect trends and underlying performance from year-to-year and are not considered normal recurring operations, including the income tax effect of the adjustments utilizing the effective tax rate. Adjusted EBITDA is net income or loss before interest expense, interest income, income taxes, depreciation, amortization, adjusted for items not considered as part of the company's normal recurring operations. Adjusted free cash flow is net cash provided by or used in operating activities, less capital expenditures, adjusted for items not considered as part of the company's normal recurring operations. Management internally uses adjusted net income or loss, adjusted EBITDA and adjusted free cash flow as performance measures and those figures will be discussed on today's call. As a reminder, we have provided reconciliations of these non-GAAP measurements to the most directly comparable GAAP financial measurements in today's press release. We encourage you to carefully review those reconciliations. Thank you, Matt. Good morning, everyone, and thank you for joining us today. And thank you to our faculty and students for enabling us to continue to operate seamlessly for another quarter and in fiscal 2022 as a whole. This past year was a pivotal year for UTI as we significantly expanded the reach and breadth of our program offering, positioning the company as a workforce solutions provider for a wide range of skills, careers and fields going forward. We made significant progress on executing on our long term strategy and entered 2023 with strong momentum, despite enduring the less than favorable macroeconomic backdrop, which has provided no shortage of uncertainties and challenges for us to manage through. Some highlights for the year include the addition of two MIAT campuses and their eight new programs early in '22, while making significant progress on the planning and rollout activities for the initial MIAT program expansions in 2023. Opening two new UTI campuses in the second half of the year in Miramar, Florida and Austin, Texas, both initially launching with our automotive, diesel and welding programs and with additional space available for MIAT expansions. Launching two new welding programs in Mooresville, North Carolina and Exton Pennsylvania, expanding our industry aligned training relationships with key manufacturer partners including Volvo and BMW and continuing to execute on our electric vehicle strategy, both in our core curriculum and with several of our industry partners. Revenue for the year was up 25% to approximately $419 million while adjusted EBITDA was up 72% to approximately $56 million, while new student starts grew 2.7% for the year. All of these major metrics are either in line or at the high end of our most recent guidance. Troy will provide more color on both the year and the quarter with his comments in just a few minutes. As I touched on earlier, 2022 was not without challenges, with the effects that Omicron had earlier in the year and then worsening of the macroeconomic environment later in the year, creating some real and persistent headwinds with respect to enrollments in 2022. Specifically, in our adult channel prospective students have been navigating the challenges stemming from record inflation levels, which directly affect the affordability of both education and the very basics of life. While interest in our program remains strong, these difficulties negatively impacted both the student enrollment and start rates, most notably in our third and fourth quarters. Though the microeconomic backdrop remains unpredictable and while many believe we are headed for a recession given the Federal Reserve's intention to slow down the economy to bring inflation under control, it's worth noting that we're starting to see some modest improvements in our year-over-year adult population enrollment performance. While we have opportunity for further improvement, we're pleased with the interest in our programs, pace of new student enrollments and overall progress we're making in 2023. Further, as noted last quarter, we've taken proactive steps to mitigate challenges in the adult channel by adding admissions resources to our high school and military channels, which have been less impacted by the macro factors. We've also enhanced our support programs to further assist students as they work due the financial barriers associated with challenges such as relocating in order to start their path to a stable and rewarding career. Importantly, our outcomes remain strong. We recently submitted our annual [indiscernible] outcomes reporting and I'm happy to report we had another year of at least a 60% graduation rate and at least an 80% in field job placement rate on an overall average basis. Our strong student outcomes, along with our healthy capital structure positions us well to make continued progress executing against our growth initiatives and reaching the fullest potential of our growth and diversification strategy. Turning our attention to 2023. I'd first like to formally welcome the faculty, staff and students from Concorde Career Colleges to the company. As announced earlier this month, we closed the Concorde acquisition on December 1, which was ahead of our expectations. We sincerely appreciate the Department of Education's timely preacquisition review, which enabled us to complete this transaction within a relatively short period of time. With Concorde now added to our group of schools, this coming year is set to be another productive one and is expected to surpass 2022 for us in terms of milestones we achieve. Beyond the acquisition, which I will speak to more in a minute, we'll also see growth from our organic initiatives. Most notably, we'll be introducing 15 new programs on 10 campuses across the UTI footprint including programs in aviation, HVAC, robotics, industrial maintenance and wind energy technician training. The first program launch is on target for March of 2023 with all but one of the remaining programs expected to be launched by the end of the fourth quarter. We also will see the continued enrollment ramp and maturation of our two new UTI campuses in Florida and Texas, bringing both of those campuses nearly to their full run rate potential exiting the year. Currently, we have approximately 550 active students attending these two campuses. The addition of Concorde Career Colleges greatly expands our program offerings and total addressable market, setting the stage for the next chapter of our growth story. Not only does this move provide us with approximately 8,000 students on 17 campuses across eight states, but allows us to tap into a completely new student demographic and provide a wider range of highly in demand educational offerings and workforce solutions. Concorde has more than 20 program offerings spanning across dental, healthcare diagnostics, nursing and a variety of other critical healthcare professions. From a program format perspective, they offer courses in hybrid, in-person and in some cases fully online. The acquisition coupled with the current Universal Technical Institute offerings allows the company to more broadly address the nation's skill gap with a diverse set of workforce solutions. It will provide opportunities to help more adults reenter the workforce, provide high school and first size college students with new career paths and allow veterans the opportunity to pursue a rewarding career in a rapidly expanding healthcare industry. We're also very optimistic with the positive trends in healthcare as an industry as we expect to add more than 2.6 million new jobs over the next decade due to attrition in the workforce along with an aging population that's expected to drive increased demand for healthcare services. Looking ahead, we're very excited to integrate Concorde into our financial reporting and overall operating model, though it will be run as separately as a healthcare location division alongside Universal Technical Institute. We intend to be cautious with our integration activities and ensure that any steps we take will bolster operational efficiency, student experience and/or our future financial performance. Including Concorde for 10 months, we are establishing our fiscal 2023 guidance, which includes revenue from $595 million to $610 million. Adjusted EBITDA from $58 million to $62 million, new student starts from 22,000 to 23,500. Troy will get into more of the details on a full year outlook and segment performance shortly. From an investment standpoint, 2023 will be focused on execution with respect to the integration of Concorde and our other ongoing organic initiatives in order to ensure that the proper foundations in place as we plan for incremental new initiatives in 2024 and beyond. Through our two completed acquisitions, paired with our campus and program expansions, learning model innovations and our real estate rationalization we have essentially delivered on or have a clear line of sight towards the completion of all strategic initiatives that we previously announced. As a result, I'm happy to announce that we now expect to deliver in excess of $700 million in revenue and adjusted EBITDA approaching $100 million in fiscal 2024 and thus achieving one of our key milestones a full year sooner than we previously projected. And once again, I'll note that our current outlook is not the endpoint of our pursuit for further growth. We are expanding the vision and roadmap for our company going forward and our entry into the healthcare space opens up significantly more entry points to new workforce solutions opportunities, which will allow us to expand the breadth and scope of our growth and diversification strategy. We believe that the continued growth in our expanded core business with the benefits we will be see from the strategic investments we made in 2022 and are making in 2023 set us up to deliver strong growth in subsequent fiscal years. I'd now like to turn the call over to Troy to discuss our results from the quarter and full fiscal year. Troy? Thank you, Jerome. I want to echo Jerome's comments and welcome the Concorde team to the company. We have great respect for their business and are extremely excited about being in the healthcare education space and the many opportunities that now affords us. We finished fiscal 2022 in line or above our most recent expectations and overall delivered strong financial and operational performance during the fourth quarter and fiscal year. Full year revenue increased 25% to $418.8 million, which was at the higher end of our guidance range. The increase was primarily due to higher average undergraduate full time active students, including the addition of MIAT, and higher revenue earned per student. Total revenue for the quarter increased 13.5% compared to the prior year to $110.6 million. Revenue per student for the quarter was approximately 8,700 and for the year 32,600 and is now essentially fully normalized to pre-COVID levels adjusting for annual price increases. We saw meaningful growth on the bottom line for the full year with $25.8 million in net income, representing a 77% increase from 2021 and includes the impact from the valuation allowance reversal. Net income in the fourth quarter was $2.8 million compared to $12 million. Fully diluted earnings per share for the full year was $0.38 versus $0.17 in the prior year. Shares outstanding at the end of the quarter were $33.8 million. Adjusted net income for the full year came in at $35.5 million above the high end of our guidance range. Adjusted net income in the fourth quarter was $8 million compared to $13.9 million. For the full year, adjusted EBITDA was $55.9 million versus $32.5 million in 2021, representing 72% year-over-year growth and above the high end of our guidance range. The growth in full year adjusted EBITDA was driven primarily by the normalization of revenue per student as well as our continued focus on operating efficiencies and facility rationalization. The full year adjusted EBITDA margin was 13.3%. Fourth quarter adjusted EBITDA was $14 million compared to $18.3 million in the prior year. The EBITDA net income adjustments are consistent with what we have reported throughout the year. As we noted last quarter, we are not immune to inflationary pressures, but we were largely able to offset them this year through cost efficiencies and revenue growth. For the year, new student starts increased 2.7% which was in the middle of the updated guidance range we set in August. Average active students in the fourth quarter increased 4.5%, while new student starts decreased 3.2% from the prior year quarter. Recall, we discussed last quarter the success we had starting more high school students in June shortly after graduating versus them waiting until August or September to start their career training. This was reflected in the 25% year-over-year growth rate last quarter. However, that negatively impacted growth in the fourth quarter. Given this dynamic, it's more meaningful to look at the first half of the year versus the second half. We clearly gained momentum in the second half with a 5% year-over-year growth rate versus down 2% in the first half. Looking at our admissions channels. As we noted previously, we saw significant pressure in adult during the year, given the macroeconomic challenges these prospective students faced as the year progressed. While we ultimately did not achieve our initial overall new student start expectations for the year, our flexible business model allowed us to adapt in strategically invest in areas that we feel will maximize our results. In addition to continuing to optimize adult performance, we have opportunities in both high school and military and have already made investments to drive growth in both of these channels in 2023. Next, I will give a quick update on our balance sheet as well as our financing activity. As we recently announced, in November, we established a $100 million revolving credit facility with Fifth Third Bank. This increases our financial flexibility and bolsters our capital structure to be more consistent with our peers and to align more closely with companies of our size and growth prospects. In short, we view it as good corporate hygiene and as a beneficial resource to support both working capital needs and future opportunistic growth initiatives, organic or inorganic. Proceeding the close of the Concorde acquisition, which was for a purchase price of $50 million, we drew $90 million from the revolving credit facility to ensure sufficient balance sheet flexibility and cash liquidity. Also for reference, Concorde had approximately $30 million of cash on their balance sheet at the closing. In short, we have a very strong balance sheet with significant total available liquidity. Moving to the reported balance sheet. We ended the year with total liquidity of $95.4 million. Full year capital expenditures were $79.5 million, including $28.7 million for the Lisle, Illinois campus purchase. Excluding Lisle, we spent less than our originally anticipated CapEx range for the year. Approximately 60% of the spend was tied to growth initiatives, namely the two new campuses and the two new welding programs, approximately 25% of the CapEx supported our now completed facility consolidation projects in Avondale, Arizona and Orlando, Florida and the remaining 15% supported to various other initiatives as well as maintenance CapEx. We generated strong cash flow from operations for the year of $46 million, while adjusted free cash flow in the year was $34.9 million, which was in line with our full year guidance and down slightly on a year-over-year basis. Our low leverage ratio and high cash flow generation will serve as integral components in fueling the continued expansion of our business and provide us with flexibility as we pursue future growth initiatives. Next, I'll spend a few minutes discussing the Concorde acquisition and the expected contribution to UTI. For reference, during the 12 months ended September 30, 2022, the Concorde generated unaudited results of approximately $200 million of revenue and $17 million of adjusted EBITDA, both showing healthy year-over-year growth. Also as of September 30, it had approximately 8,000 students. Starting in 2023, we expect to report in two segments. UTI, which will include the current transportation, skilled trades and energy offerings, and Concorde which will be the acquired Concorde Healthcare Education business. We also expect to report unallocated corporate costs. Operationally, the segments we managed independently with the primary integration in 2023 focused on critical items like financial reporting, implementation of Sarbanes Oxley and Audit requirements, IT security and limited others. We will proceed cautiously with integration activity with an emphasis on operational efficiency, student experience and clear financial benefits. As we move into fiscal 2023, we believe that the initiatives that have been put in place paired with targeted investments we are making across the business, will drive continued growth. Our 2023 guidance includes the 10 months of Concorde contribution from December 1, through September 30, with any year-over-year impacts represented on an as reported basis. With that said, our outlook for 2023 is as follows: for new student starts, we expect a range of 22,000 to 23,500, roughly 14,500 to 15,500 will be delivered by UTI, while 7,500 to 8,000 will be delivered by Concorde. As far as pacing through the year, we expect UTI to be heavily influenced by the additional investment in the high school channel, the ramping of the two campuses launched in 2022, and the program expansions primarily in the fourth quarter. Given that, growth will be measurably skewed towards Q3 and Q4. Concorde starts will also have a Q4 bias with a little more than half of the starts across Q2 and Q3 and the remainder in Q4 and a minimal impact in December. We expect revenue ranging from $595 million to $610 million. From a segment perspective, we expect UTI to show low-single digit year-over-year growth, while we expect Concorde to contribute approximately $170 million to $175 million for the year. The lower than initially anticipated UTI new student starts in 2022 along with the timing of the new campus launches, increasing contribution from the high school channel and 2023 program expansion all impact the pacing of UTI revenue throughout the year, with growth skewing towards the second half. Similarly, Concorde's revenue will be skewed more toward the second half given the partial Q1 and seasonality of their business. We anticipate total adjusted EBITDA within a range of $58 million to $62 million. We are still working through the mechanics of our segment reporting structure, thus are not ready to provide target margins by segment at this time. However, I will offer that on a like-for-like basis, we expect to see some margin compression in 2023 on the historical UTI business given the lower revenue flow through from 2022, new campus and program expansion ramps, ongoing investments to support our growth and diversification strategy and in our emissions channels and pockets of inflationary pressure. We will not see the full benefit of the addition of Concorde in 2023 adjusted EBITDA for a few reasons. First, due to seasonality, December is not a profitable month, while the pre-close months of October and November are very profitable. Additionally, we will have certain run rate cost impacts from bringing them into the UTI and public company environment before we have the opportunity to realize any meaningful operating synergies. The combination of these factors means their contribution for fiscal 2023 will be well below their September 30, trailing 12 months adjusted EBITDA. For pacing, we expect total adjusted EBITDA will be down year-over-year measurably in Q1 and overall in the first three quarters and significantly higher year-over-year in the fourth quarter with roughly half of the full year adjusted EBITDA being delivered in the fourth quarter. As far as our non-GAAP adjustments, in 2023, we will begin including stock-based compensation expense as an adjustment. As you can see with our 2022 results, this has become a more material expense for us as we have been maturing our stock compensation program with the company's return to sustain profitability. Note this is also a consistent practice with our peers and many other companies. Otherwise, we expect similar adjustments in fiscal 2023 to what we had in 2022 with the addition of Concorde related acquisition, integration and program expansion costs. Note, we included non-GAAP guidance reconciliation tables in our press release and investor presentation. For adjusted net income, we expect $14 million to $18 million. Note, we expect both a GAAP and non-GAAP tax rate of 25%, which is a significant increase over 2022 reflective of the valuation allowance reversal. And finally, we expect adjusted free cash flow between $40 million and $45 million, which assumes total CapEx within a range of $36 million to $40 million before adjustments. CapEx includes residual investments for the Austin and Miramar campuses, UTI and Concorde planned program expansion and a consistent level of annual maintenance CapEx. We will adjust out about half of the expected 2023 CapEx as one-time growth investments. As far as pacing, we expect a heavy skew to second and third quarters as we prepare for the fourth quarter program expansion launches. Last, we do not expect to be a cash federal taxpayer in fiscal 2023 as we continue to utilize accumulated net operating loss carryforwards. Please be sure to review our press release, financial supplement and investor presentation, which have all been updated for the most current details about our actual results and our guidance. Reiterating Jerome's comments with our fiscal 2023 plan, we should carry tremendous momentum heading into 2024 and beyond. Our confidence in this plan along with the timely execution of the Concorde acquisition allows us to pull forward the timing of our previously provided longer term outlook. As such, with our currently announced and in flight initiatives, we now expect to deliver an excess $700 million of revenue and adjusted EBITDA approaching $100 million in fiscal 2024 with additional revenue and adjusted EBITDA growth in 2025 in subsequent years both from our existing business and initiatives and potential future growth opportunities. We continue to make significant progress as we execute on our growth and diversification strategy and are building for the future of UTI. We believe we have set ourselves up well to drive shareholder value 2023 and beyond. With that, I want to thank the UTI team, our students and our partners for their efforts and ongoing support and again welcome the Concorde team to the company. I'll now turn the call over to Jerome for closing remarks. Thank you, Troy. To summarize, we're pleased with our performance this past year. Not only did we deliver against our stated financial goals for the year, in an environment that became increasingly more challenging as the year progressed. But importantly, we demonstrated the flexibility we built into our business as we proactively responded to shifting landscapes across the specific student channels, addressing the needs of our constituents (ph) as they look to further their career goals through our programs. As we enter our 2023 fiscal year and expand our set of work force solutions offerings to the healthcare field with the addition of Concorde, it's worth noting how far we've come in just a few short years. Comparing our fiscal 2023 guidance to 2020, we will have more than doubled revenue and more than tripled adjusted EBITDA while also strengthening our balance sheet. We are a significantly stronger and healthier company financially and have dramatically expanded the breadth of our program set and our geographic footprint, and as a result the growth pathways in front of us. Our business strategy is long term focus as we don't manage to a specific economic forecast or outlook nor which political party is in favor or power. With that said, it certainly has been the case in prior periods of economic uncertainty and rising unemployment that our business has benefited as workers look to our offerings as an opportunity to upgrade their skills and position themselves for long term stable careers and we're well positioned to support them. Thank you. We will now begin the question-and-answer session. [Operator Instructions] Today's first question comes from Eric Martinuzzi with Lake Street. Please go ahead. Yes. First to comment and then we'll get into questions, really, you guys have had a terrific fiscal year just getting the new campuses up and running, but also wanted to congratulate you on the completion of the Concorde acquisition. So getting into the questions, I wanted to just get your take on the macro demand versus kind of 90 days ago or less when you report Q3, the unemployment figures don't seem to have changed too much, but just wanted to know what's it like from the ground level view? Sure. Hey, Eric. How's it going? It's Jerome here. So as we said in our comments, we've started to see improvement in the adult channel. What I mean by starting to see improvement is that we watch as we've mentioned in our previously quarter results, both conversion rates of leads, which again are still operating at a very high level. Our lead flow is very, very strong, conversion of those leads into enrollments and then show rates of students. The number of students who go through the process of financial aid and housing and, excuse me, thinking about their jobs while they're in school, et cetera. And in October and November, we've seen improvement over last year's third and fourth quarter. Is it back to normal? No. But the gap is beginning to close and that's a great sign that we're seeing. We're starting to see some -- a little more unemployment in the 18 to 24 year old range in unskilled labor jobs, the construction markets and things along those lines and we're getting just a little bit more engagement than we saw last year, but I want to make sure I outlined, we're not saying it's back to normal. What we're saying is that compared to the third quarter and fourth quarter of last year, we've seen improvement. Okay. All right. And then if I could just go layer deeper on your outlook for new student starts. The -- I understand we've got the -- there's a legacy business and then there's the incremental students from Concorde, but we've also got kind of new students from the new campuses. What is it? If we just kind of go back to a same-store sales, if I strip out Concorde and if I strip out Austin and Miramar, what is the kind of the new student start implied in those campuses? Yeah. Hi, Eric. It's Troy. Our base assumption as we've talked about in prior quarters is low to mid-single digit growth out of the base. And then growth initiatives, additives to that, so that's our starting point for our fiscal ’23 view for the same-store, if you will. And of course, a little bit of a shift as Jerome was just talking about with adult, we're not counting on growth from adult in ’23 [Technical Difficulty] last year in '22, really that growth coming primarily out of high school and military and with that then a skew toward later in the year given the timing of ramping those admissions resources as well as just when those students would start their programs. Got you. And then what's the -- last question for me, the current thinking on tuition, you're obviously facing greater inflationary pressures on your cost side? What's the thinking on tuition increase? Well, build our model around a fairly consistent low-single digit annual increase. We did shift our timing a little bit this year. Historically, it would be in February or March. We did pull it forward to January 1 and we're contemplating some further timing shift as we get into fiscal ‘24 to do a little bit of catch up, if you will, given the cost escalations we've seen in various areas. Good afternoon. Good morning and congratulations again on Concorde and this new close. Given this shift in dynamic towards high school, could you just remind us what the adult high school military mix was in FY '22 and what that looks like in ‘23 for UTI? Sure. Thanks for the question Steve. I actually had add that. It's -- if we got ‘22 ended up being overall, so all-in including MIAT was about 42% adult, 44% high school and about 14% military. MIAT is more skewed toward adult. So if you just look at UTI, it's more like 40%, 45% and 15% or 20%. Okay. And then in terms of Concorde, obviously, you've got some investments in synergies that are going to be pushed out. But in terms of what's going on the ground, does their business look incrementally stronger or incrementally weaker than six months ago? I would say it's relatively -- add a little bit of a waiver maybe early in the calendar year, this year, but then they've done pretty well the last few quarters. They had good growth in their business, in the trailing 12 month period through 930 (ph), both in revenue and starts and we feel good about some growth there as well. They've had some program expansions that they've been working on the past two years. So a few programs dental hygiene in particular that are ramping and fill very nicely. So we feel pretty good. It's a different market, adult, female and primarily local, in fact almost all local. So it's a really different dynamic than the UTI business. [indiscernible] diversification is great. And then from a regulatory standpoint, are there any programs or campuses on the Concorde side where there's some concern in terms of where they are relative to where they need to be? They have one or two campuses where their 90:10 ratio and again that's measured at the OPEID level, they -- Concorde operates with 12 OPEID. So there's a few of them that have multiple campuses, but many of them have a single campus. And they had a few that are in the mid to upper 80s on the 90-10, but this program expansion I mentioned contributes nicely to bringing that down and they have some other strategies where sales, we'll see some improvements in those ratios. But so no concerns, it's some things that are being managed, but no concerns. Hi. Good morning. Thank you for taking my questions. I wanted to understand the guidance, the adjusted EBITDA guidance for ‘23. So the core UTIs business that are margin pressures and I just wanted to understand if you could provide more color on, you're getting those margin pressures because the adjusted EBITDA guide is kind of flat to less to ‘22. But then how do you -- how do those pressures revert and help you get back to the -- getting to your $700 million and $100 million EBITDA a year earlier? Sure. Yeah. Thanks, Raj. It's Troy. Well, as we mentioned, so at an overall, call it, 3% growth rate in ‘22 with really all of that being driven by the addition of MIAT and then the new campuses, new welding program. So same-store, we were down measurably, again driven heavily by adult, but still down nonetheless. And with the leverage that we get on the upside, on our margin, we unfortunately had to reverse that happens as well. So we start the year, we have some bridges in our investor materials that have spent some time looking at with you as well, but we see the opposite on the way down. We had a very, very strong Q1 of '22 because of that same effect, we had very strong student growth in '21. The costs had not yet caught up with all the student inflows and so we had $20 million in adjusted EBITDA in Q1 of last year, which was frankly a bit of a windfall. So as we move through the year, though, we also had the new camp is ramping, Miramar just had its first class in August of last year, so that will be operating at a loss for the first half of the year. We have the program expansions that will be in the fourth quarter. We'll have the pre-marketing costs and we'll adjust out some of the startup costs. So there's just a number of factors in the first part of the year that will weigh us down on the UTI business and then reverse as we get into the fourth quarter and into ‘24, which to the latter part of your question is then the momentum that we carry into ‘24 with both the base business, as well as with the growth initiatives in the full year of Concorde, which give us confidence in the $700 million and approaching $100 million in ‘24. Great. Thanks. Thanks for that clarification. And then just one other question on your draw of $90 million on the revolver. Can you talk about how much of that is the working capital sort of how do we think about working capital needs for the year in the first half, some more color on that? And then how much is it being used for corporate purposes entirely? Sure. Yeah. We wanted to make sure we had a stronger balance sheet as we could going into the closing, there's various activities that occur around the closing that we just wanted to make sure we had ample liquidity. We have no concerns about working capital. We have -- we will be carrying excess cash probably through most of the year. So as we mentioned in our prepared remarks, we'll continue now looking at the next leg of our growth and diversification strategy, both organic and inorganic opportunities don't know that anything incremental would be delivered in ‘23 necessarily, but certainly we'll be doing planning in looking at those next opportunities and where to deploy capital, which we have plenty of. Correct. They had a very good way. drone cash balance as well and of course, there was a working capital element to the closing settlement and all that came relatively aligned to our expectations. And just exactly on Concorde, what growth -- what are the growth expectations for '23? I know they ended the year with $200 million and $17 million in EBITDA. Any sort of indication on how Concorde is expected to do? Well, again, it will be a partial year, so it will be hard to compare and unfortunately as I mentioned in my comments, December as with UTI business is a weaker month. But I would say, overall, if we were looking at more of a pro forma view of ‘23, a few points of growth, maybe 5% growth, top in line and a little bit more on EBITDA as they again with growth you get leverage on fixed costs and SG&A and the like. So you get a little bit of enhanced effect from a profitability perspective and starts as well some good growth there mid to upper-single digits. And ladies and gentlemen, this concludes our question-and-answer session. I’d like to turn the conference back over to the management team for any final remarks. Thank you very much. Well, this concludes our session for today. I want to wish you all very happy holidays and thank you for joining us. We'll talk to you in a few months. Thank you. Bye-bye. Thank you, sir. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.
EarningCall_1487
Good afternoon, everyone, and thank you for participating in today's conference call to discuss Educational Development Corporation’s Financial and Operating Results for its Fiscal Third Quarter and Fiscal 2023 Year-to-date Results. As a reminder, this conference is being recorded. Thank you, operator, and good afternoon, everyone. Thank you for joining us today for Educational Development Corporation’s third quarter and fiscal 2023 year-to-date earnings call. On the call with me today are Craig White, President and Chief Executive Officer; Heather Cobb, Chief Sales and Marketing Officer; and Dan O'Keefe, Chief Financial Officer. After the market closed this afternoon, the company issued a press release announcing its results for the third quarter and fiscal 2023 year-to-date. The release is available on the company's website at www.edcpub.com. Before turning to the prepared remarks, I would like to remind you that some of the statements made today will be forward-looking and are protected under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those expressed or implied due to a variety of factors. We refer you to Educational Development Corporation's recent filings with the SEC for a more detailed discussion of the company's financial condition. With that, I would now like to turn the call over to Craig White, the company's President and Chief Executive Officer. Craig? I will start today's call with some general comments in regard to the quarter, then I will pass the call off to Dan and Heather to run through the financials and provide an update on our sales and marketing. Finally, I will wrap up the call with some comments and strategy and 2023 outlook. We are pleased with our sales for the third quarter, especially when compared to the previous quarter. We continue to face macroeconomic pressures from record inflation, resulting in high food and fuel costs that have hit the pockets of our target customers, which are families with young children. To combat these continued pressures like many retailers, we offered additional discounts to support our customers and additional incentives to energize our sales force. These market decisions allowed us to generate over $30 million in net sales, but did impact our ability to drive the bottom-line. Having said that, I am pleased by our ability to remain profitable for the quarter. Turning to the third quarter, net revenues were $30.3 million, a decrease of $14.8 million or 32.8% compared to $45.1 million in the third quarter last year, or an increase of 56.2% as compared to $19.4 million during the previous quarter. The annual decrease is due to the positive benefit we saw a year ago driven by the pandemic. The quarter-over-quarter increase is primarily due to the seasonality and also included some promotions and incentives. Average active UBAM sales consultants totaled 27,100 compared to 41,500 in the same period a year ago, and 26,800 in the previous quarter of this year. During the third quarter, we saw stabilization in the average active number of consultants. We've seen our active consultant levels begin to rebound while our leader level consultants remain at historically high numbers. Earnings before income taxes for the third quarter was $0.0 million, a decrease of $3.6 million compared to $3.6 million recorded in the third quarter of last year. Net earnings for the quarter also totaled zero compared to $2.6 million, a decrease of $2.6 million. Earnings per share totaled zero compared to $0.31 on a fully diluted basis. Now turning to our year-to-date highlights. We recorded net revenues of $72.8 million, a decrease of $46.1 million or 38.8% compared to $118.9 million during the same period of 2022. The decline was primarily due to lower active consultant count coupled with rising inflation, especially during the first and second quarters this year. Average active UBAM sales consultants totaled 28,700 compared to 47,300 for the first three quarters of 2022. Last year, we saw inflated numbers continuing from the pandemic when school closures continued and many family members worked from home. This year as schools remained open and families returned to work, we've seen our sales consultant levels start to normalize. Year-to-date loss for income taxes was $800,000, a decrease of $11.7 million compared to $10.9 million during the same time last year. Net year-to-date loss totaled $600,000, compared to $8.6 million for the first half of last year -- for the first three quarters of last year, a decrease of $8.6 million. Year-to-date loss totaled $0.07 compared to earnings per share of $0.94 from the first three quarters of fiscal 2022, down 107.4% on a fully diluted basis. To update everyone on our working capital levels, inventory levels decreased from $67.6 million at the end of the second quarter to $64.3 million as of November 30, 2022. Cash generated from our reduced inventory was primarily used to pay down our working capital line, which ended the quarter at $9 million. We continue to expect further inventory reductions and working capital line paydowns during our fiscal fourth quarter and throughout fiscal 2024 as we normalize our inventory levels. Lastly, our longstanding dividend program remains paused as part of the strategic decision to preserve cash, which improves cash flows by approximately $1 million per quarter. This concludes the financial update. I will now turn the call over to Heather Cobb to talk about sales and marketing opportunities in further detail. Heather? As Craig mentioned earlier, we continue to evaluate market conditions and make changes we feel are needed to motivate our sales force and engage our customers. We ran several customer discount promotions and sales incentives during the quarter to ensure strong results during our peak seasonal selling period. These market decisions not only helped us normalize our working capital, but also keep our commission-based salesforce engaged. During the second and third quarters, our sales and marketing teams internally spent significant efforts executing a rebranding directive for our direct sales division. We announced the rebranding efforts in June, engaged a Tier-1 rebranding firm to assist us and completed and announced the new name of our direct sales division PaperPie in December. This new name allows us to better showcase our full product offering: Kane Miller Books, Usborne Books, SmartLab Toys and Learning Wrap-Ups. PaperPie also allows us to build a recognizable name unique to our company. Our rebranding process was completed earlier this week when we transitioned our customer facing ecommerce and brand partner facing back office to the new paperpie.com. We are extremely excited about our new name, PaperPie, as it does allow us to build a recognizable brand, encompassing all of our wonderful products and people. There's a lot of meaning behind the name. But overall, we wanted our brand to represent our mission of gathering for good around literacy and learning. This is a newly-formed compound word which we will be defining ourselves. At PaperPie, paper is our medium of communication, whether it's a board book, game pieces, a series of chapter books or creative activity. As the world continues to fight for our children's attention through screens and devices, it has never felt more important for tangible literacy and learning tools that will feed the imagination, grow the emotions and nourish the mind of our children. And when you think of pie, you think of something to be gathered around something to be shared an experience worth savoring. That's exactly what we believe our products are made for, literacy and learning as a lifestyle. PaperPie is for memory making, creative learning and unlimited possibilities, all within the context of togetherness. Along with this strategic rebranding, starting this week, we rolled out our SmartLab Toys product line. These award-winning theme-based products, including squishy human body, laboratory toys, science lab toys and our tiny series offer children ages eight and up hands-on learning opportunities. We expect our initial launch of 10 products to have an immediate sales impact and we plan to follow that up with additional product releases mid-season this spring and another significant release this summer. EDC has decades long history of profitability. We have been profitable during recessions and other challenging times. During this past year, our product costs and sales commissions have remained unchanged, but other costs have increased, especially in the areas of inbound and outbound freight. As our earnings have been impacted, we have made recent changes to improve profitability, including increasing the freight we charge our customers. This was done late in the quarter, so had a small impact so far. We have also made changes to reduce our operating expenses, and we are seeing inbound freight rates come down and are taking advantage of better spot rates. We expect these changes will yield profitable results even on reduced sales volumes. As we return to higher profitability, we plan to reinstate our longstanding practice of paying quarterly dividends to our shareholders. This has been and continues to be a top priority for myself and our shareholders. Turning to future expectations, I want to highlight some exciting changes happening at EDC. First, I want to thank Heather and our sales and marketing team for the successful rebranding. Launching PaperPie was a great accomplishment. I expect not only short-term benefits from the excitement surrounding our new name, but a positive momentum building trend in our PaperPie brand partner count as we rally around our new names, our improving and diversified line of products and our improved IT systems. We recently hired a new Chief Information Officer John Leach that brings 30 years of IT experience and 20 years of IT experience in the direct sales industry. His guidance and leadership supporting our PaperPie launch was a key to its success and the additional resource library that was added to our brand partner success platform. He has taken the lead on several IT projects, and we have new products and system enhancements that will not only make our existing PaperPie sales brand partners more successful, but offer new brand partners a shorter path to financial success selling our products. We will be rolling out several system improvements over the next few months. Lastly, I'd like to talk about our new product line SmartLab Toys. This product line has a long history of sales success, but has never had a marketing and sales engine like PaperPie, where we have a much broader reach. Also, our trade retail division has outside sales groups who have represented the product line in the past and are ecstatic to get the line back. SmartLab Toys' most recent year sales was $7.5 million and we feel very good about being able to exceed that. We do not need to acquire companies to continue to diversify the product lines. We have been working with existing vendors to provide more educational games and toys, and we begin selling some of those this week. We will continue to look for opportunities with our existing vendors as well as outside opportunities. Now that we have provided a summary of some of our recent activity, I'll now turn the call back over to the operator for question and answer. Okay. So, how about I'll ask my three questions, and then I'll hang up and listen to your response. First, UBAM's net sales per average consultant this quarter was $941, down 6% from the same quarter last year and down 17% from the same quarter just before COVID. In fact, this is the fourth year in a row that Q3 sales per consultant fell. Are your consultants selling less each year or is your definition of active consultant becoming more liberal? Secondly, this past June, Usborne Publishing Limited in U.K. applied with the U.S. Patent and Trademark Office to register the UBAM trademark and expressly stated that it intends on using this trademark in commerce. Is Usborne planning on launching its own MLM business to compete directly with PaperPie? And finally, your Usborne distribution agreement specifies minimum revenue targets that you must order from Usborne. What are these amounts? Thanks for your time. Thanks, Alan. Sure. Let me address the -- well, I will address all of them. But our sales per consultant going down has mostly to do with the economic factors. But I will say the new distribution agreement that we signed with Usborne this summer caused a great deal of confusion and chaos and wondering what the future was going to look like as we had to get to this major rebrand. So, I think that's a lot of it. I won't say we're necessarily on a downward trend. I think there's a great deal of excitement around the new brand. It's very exciting that PaperPie, as Heather mentioned, is in a very clean URL and social media space. So, they are really rallying around the new name. And so, I don't anticipate that trend will continue, but that remains to be seen. UBAM, they are not launching their own MLM division. The whole idea around this rebrand is that they're trying to protect their global brand. And that's what caused us to need to rebrand. As you know, Usborne Books more has the word Usborne in it, and they want us to rebrand. So, they're just trying to protect it, so that doesn't get taken going forward. But we have no indication that they're going to compete with us in a multi-level marketing division. Yes, we had minimum -- we have not published the minimum purchase agreements. They're working with this. They know this is a difficult economic time, and we fell just short of it. But again, they're working with this. Thanks a lot. I'm curious about the impact of inflation on your year-over-year and quarter-over-quarter growth. In the release, you talked about how inflation has an impact. I'm just hoping you could quantify that, or put it in a range of how much inflation contributed to the quarter-over-quarter growth for the year -- for the quarter, excuse me? I don't think we can quantify inflation's impact. It's just that whether we like to believe it or not, children's educational products are a discretionary purchase for young families. I don't think there's any way we can quantify that. No, I mean -- so the key thing we look at, and we -- as we said in the call, we make market decisions based upon sales activities, and we are constantly looking at what we need to do to capture sales and grow sales. And so, we ran some promotions this quarter and offered some additional incentives just to make sure that we were capturing as much of the business as we could. And that was my second question, the release also talked about discounts and incentives. Are those expected to continue for the next couple of quarters? Or is this a one-time thing? Like Dan just said, we always try to react to sales and marketing conditions at the time. We don't expect -- it's not a company-wide decision to discount or do any of those kind of things, but we kind of spur and try to ignite the salesforce whenever we see it's necessary. [Operator Instructions] Next question, we have [Cliff Morton] (ph), a private investor. Cliff Morton, please ask your question. Cliff Morton has disconnected his line. Thank you. Good afternoon, Craig and Heather and Dan. Question, are there any other lines that you might add in addition to the squishy skeleton? In other words, any other kind of theme that you might be able to add to that product line or those offerings, I guess? Yes, good question. So, SmartLab Toys over their history have introduced 40 or 50 products. And some of them have been discontinued, but we're looking at bringing back any or all or any combination thereof. So, they had several basic category groups, I would say. They had a circuits group of products. They have the Chinese. They have the squishies, which there's a squishy brain. And they have a new product that they actually never sold before we acquired them, which is the ultimate squishy human body, which is much more integrated with electronics. I mean, you can put organs on this little electronic pad and you can do quizzes on that organ, you can keep track of the quizzes. And so that's another product in that line. But like I said -- and then there's science labs and some of those things. So, we have a wealth of products that we can bring out. We didn't want to overwhelm and bring out 20 or 30 all at once. So, we're kind of spacing those releases out, but yes, there are further products. So, might an approach be to inquire of your consultant lines of inquiries about some of those products that you haven't introduced yet? In other words, rather than human anatomy type products, maybe cats, dogs, that kind of thing? As Craig mentioned, they have a catalogue of products for us to continue to pull from. But in addition to that, we also kept on staff one of their creators and developers, who is responsible for the creation of these products. And we have already been in conversations and brainstorm sessions about what's next as far as the creation process. So, we have the best of both worlds. We can pull from the back list of their catalogue, and we also are planning to create some of our own things to follow up with. Okay. Well, I'm just wondering that if you question those in the consultant line and get their feedback of any interest about certain products from their downline or whatever the people that are having at their parties and whatever, and kind of query them as to what's going on or that might give you a better idea of what the public wants, so to speak, is that an approach you're considering? It's actually approach that we already use. We have constant interaction with our field to receive feedback, to get ideas. We have an entire section of our back-office support ticket category to take recommendations and suggestions. And so that's what we've already been doing with our product lines, is taking the temperature of our field as well as the customers' watching trends and seeing where we can fill gaps that we currently aren't offering or isn't available in the market otherwise. Yes. My question is, since I had difficulty logging on and missed the part that I wanted to learn about was the price of stock. Where would I access the recording of this? Following our call today, we will get a recording and put it on our Investor page of our edcpub.com website. So, if you go… Where and under what -- I looked there when I was trying to log on. So, what's it going to be under, Welcome Corporate Filings, Governance or FAQ? Hold on just a second. We'll pull it up right now. And I can direct you there. You can find them under Investors, in Corporate Filings and then there's Earnings Calls. Okay. There's nothing under Corporate Filings at this point, right. It's Earnings Call option. Okay, with the press releases, would I've been able to get the phone number to call in online, because I couldn't find it and the receptionist couldn't get it for me? Yes. So, we filed an 8-K couple of weeks ago that gave the earnings call information. It was an earnings call announcement. And then, we also filed an 8-K and a press release today that both included the earnings call number. Yes. If you go to that SEC filings and open up that first 8-K, and then you can walk through that 8-K announcement, and at the bottom, there's a third quarter earnings call information. Okay. I can't, but I got to EDGAR's search results -- but that's all right, I can get a recording later someplace. Yes. The EDGAR search results are correct. And then if you click on that 8-K, under the EDGAR search results, it'll open up our press release. Okay. And 8-K means what? I mean, I'm at search results, and I see filing type. Do I type in 8-K there? Yes, thank you. Thanks, everyone, for joining us on our call today. We appreciate your continued support and look forward to providing you additional update when we report Q4 in May. So, again, appreciate your support. Reach out anytime, and thank you. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating, and ask that you please disconnect your lines.
EarningCall_1488
Ladies and gentlemen, thank you for standing by and welcome to the TE Connectivity First Quarter 2023 Earnings Call. At this time, all lines are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions]. As a reminder, today's call is being recorded. I would now like to turn the conference over to our host, Vice President of Investor Relations, Sujal Shah. Please go ahead. Good morning and thank you for joining our conference call to discuss TE Connectivity's first quarter 2023 results. With me today are Chief Executive Officer, Terrence Curtin and Chief Financial Officer, Heath Mitts. During this call, we will be providing certain forward-looking information and we ask you to review the forward-looking cautionary statements included in today's press release. In addition, we will use certain non-GAAP measures in our discussion this morning and we ask you to review the sections of our press release and the accompanying slide presentation that address the use of these items. The press release and related tables, along with the slide presentation, can be found on the Investor Relations portion of our website at te.com. Finally, during the Q&A portion of today’s call we are asking everyone to limit themselves to one question and you may rejoin the queue if you have a second question. Now let me turn the call over to Terrence for opening comments. Thanks, Sujal and thank you everyone for joining us today to cover our results for our first fiscal quarter along with our outlook for our second quarter. Before Heath and I take you through the details on the slides, I do want to take a moment to discuss our performance within the backdrop of the current environment along with what we're seeing since our call 90 days ago. Clearly, we're all experiencing a lot of moving pieces in the global macro environment. While this volatility is creating cyclicality in specific end markets, we continue to benefit from secular trends leading to outperformance across many of the markets we serve. The strategic positioning of our portfolio and our team’s execution enabled us to deliver sales and adjusted earnings per share that exceeded our guidance and we also delivered strong free cash flow in the quarter. We generated high single-digit organic growth year-over-year with organic growth in all businesses, in our transportation and industrial solutions segments. The growth in these two segments offset incremental weakness in our communication segment. And while we can't control the macro environment or the headwinds from currency exchange effects, we are taking actions on the elements of our business model that we can control. Our industrial segment continues on its journey to expand margins towards its high teens margin target and we'll talk through that in the call. As well as we continue to implement price increases to offset inflation in our transportation segment. In addition, we continue to drive cost reduction and footprint consolidation efforts and are now implementing additional structural reductions in communications to ensure we stay in line with the target margins of that segment as we go forward. So let me provide some additional color on our markets and other updates since our call 90 days ago. Our view of the transportation end markets remain unchanged. Our growth will continue to be driven by content outperformance from our global leading position in electric vehicles and electronification trends even in an environment where auto production we expect to remain flat this year. Our view of the industrial end markets is also consistent with our prior view. We are seeing continued strong recovery in the commercial air and medical markets, as well as continued momentum and renewable applications in our energy business. In our communication segments, this is where we're seeing changes versus our prior review. Last fall, we highlighted that we were expecting moderation in cloud demand in our Data and Devices business and we're now seeing incremental weakness in enterprise and telecom applications along with inventory adjustments across the broader supply chain that serves the Data and Device market. And as typical our expectation is that the inventory [ph] adjustment will last a few quarters. Turning to orders from a company perspective our book-to-bill level remain below one as we expected due to the strong backlog coverage from our customers and increased stability in the broader supply chain. And I do want to highlight that our backlog remains near record levels and is almost 2X higher than we were in pre-COVID. Lastly, I do want to comment on the inflationary environment and just want to stress that we continue to be in an inflationary environment and we've negotiated additional price increases with our customers and transportation, which will take effect as we move through this year. These increases will partially offset these inflationary costs and we expect to have positive contributions to the transportation margins later in 2023 from the price cost dynamic. So with that as a quick overview, let me now get into the slides and discuss additional highlights and we'll start on Slide 3. Our first quarter sales were $3.8 billion and this was up 8% organically year-over-year. We saw market outperformance in transportation and continued growth and recovery in the industrial segment, which offset the sales decline in our Communications segment. Our sales were up 1% year-over-year on a reported basis and was impacted by approximately $300 million of currency exchange headwinds. Order of backlog trends continue to reflect a strong demand environment in both the transportation and industrial segments, and I'll get into more details about order trend dynamics by segment on the next slide. Adjusted earnings per share was ahead of our guidance at $1.53 and included $0.25 of currency exchange and tax headwinds versus our prior year. Adjusted operating margins came in as expected at 16.2%. Our free cash flow was strong at $400 million and we returned approximately $410 million to shareholders, and we'll continue to be aggressive with share buybacks, taking advantage of market dislocations and our share price. As we look forward, we are expecting second quarter sales to be approximately $3.9 billion and adjusted earnings per share to be around $1.57. Our guidance represents sequential growth in sales driven by the Transportation and Industrial Solutions segments and this will offset a sequential decline in our communication segment. Our teams remained focused on how we innovate with customers around the key secular trends that we position TE around, such as electric vehicles, renewable energy and data centers, just to name a few. Now I would like to move away from the financials just for a moment and I'm pleased that TE was named to the Dow Jones Sustainability Index for the 11th consecutive year. This recognizes our positive environmental, social, and governance policy and puts TE in the top 10% of the largest 2500 companies in the S&P Broad Market Index based upon long term ESG criteria. So let me get into the order trends in markets and I would appreciate if you could turn to Slide 4. For the first quarter, our orders were $3.6 billion and I think the key take away by segment is that we're seeing stability in transportation, strength in the industrial solutions segment, and we've seen incremental weakness in communications. I also want to highlight that as you look at this slide and you compare orders versus the prior year, there are some key moving pieces I want to highlight. First off is, while currency impact sales, they also do impact orders. And so to compare we're comparing different currency rates year-on-year. And the prior year also has higher than normal order levels due to the broad supply chain challenges we were all dealing with. I do also want to highlight, as I stressed earlier, that our backlog remains at near record levels. So let me get the orders by segment. Our transportation book-to-bill was 0.95, reflecting ongoing stable environment and strong backlog levels. On an organic basis, our transportation orders grew 9% year-over-year and it reinforces our ongoing strong content growth momentum in what is essentially a flat production environment. In our industrial segment, the book-to-bill of 1.02 reflects strong demand across most of them served end markets were in. We continue to see momentum around renewable applications and energy and are also continuing to see improving order trends in commercial air and medical as those markets continue to recover. Turning to communications, the orders reflect the incremental weakness in Data and Devices that I talked about. And the other thing I want to highlight on the orders is the appliance market is moderating as we expected and we've been talking to you about. As we continue to move through this year and continue to see supply chain improvements and a reduction of backlog levels, we expect book-to-bill levels to remain below 1, which is consistent with what we've been talking to you about. So with that as a brief overview of orders, let me now briefly discuss year-over-year segment results in the quarter that are laid out on Slide 5 through 7 and you can see the details on each of those slides. Starting with transportation, sales growth was strong. It was up 14% organically year-over-year, with organic growth across all businesses. Our auto business grew 20% organically versus auto production that was roughly flat versus the prior year. The outperformance was driven by our global leading position in electric vehicles. We're benefiting from electronification trends in the vehicle as well as some benefits from our pricing actions. While overall auto production is expected to be flat for this fiscal year, we expect production of hybrid and electric vehicles to grow approximately 25% of the total global auto production in 2023. And as you know, we generate 2X the content in EV platforms versus combustion engine vehicles. So we expect our content per vehicle to continue to expand as we move through the year. In the commercial transportation business, we saw a 3% organic growth, driven by growth in North America and Europe. And this growth was partially offset by declines driven by a continued China market that's weak. And in our centers business, we grew 3% organically and that was driven by our growth in automotive applications. At the Transportation segment level, adjusted operating margins were 15.8% as expected, reflecting the lag in the timing of price actions to offset inflation. Over the past three to four months, we took incremental cost actions and are implementing additional price increases to improve margin performance. We expect adjusted operating margins to improve sequentially into quarter two and get back to the high teens in the second-half of this year as we mentioned last quarter. Now let me turn to the industrial segment. In this segment, sales increased 7% organically year-over-year, with organic growth across all businesses. Our industrial equipment business was up 3% organically, driven by continued benefits from automation applications. Our AD&M business was up 14% organically with growth driven primarily by ongoing improvement in the commercial air market. In energy, we saw 8% organic growth with continued momentum in renewable applications. And our medical sales were up 5% organically and we're benefiting from the recovery and interventional procedures. As you can see on the slide, from a margin perspective, we expanded adjusted operating margins by almost 200 basis points and we continue to make progress towards our high teens margin target for this segment. Now let me turn to Communications. And in this segment, our sales were down 11% organic. The appliance market is down as we expected and as you would expect, with the benefit we got during COVID as it turns, we saw declines across all regions in this business. Our Data and Device business was down 6% organically, and this was driven by broad market weakness, which I already discussed. In the Communications segment, adjusted operating margins were 17%, driven by lower volume including declines in higher-margin distribution sales. We are taking additional cost actions to improve margin performance in this segment as we go forward. We will balance these actions with investments for growth as we continue to see strong design win momentum in next-generation platform serving the cloud data center market. So with that as a quick overview of our performance by segment, let me turn it over to Heath, and he'll get into more details on the financials as well as our expectations going forward. Thank you, Terrence and good morning, everyone. Please turn to Slide 8, where I will provide more details on the Q1 financials. Adjusted operating income was $622 million, with an adjusted operating margin of 16.2%. GAAP operating income was $502 million and included $111 million of restructuring and other charges and $9 million of acquisition-related charges. You'll note that we have taken nearly $200 million of restructuring charges over the last two quarters as we aggressively optimize our manufacturing footprint and improve the cost structure of the organization. We now expect full year restructuring charges to increase versus last year and as we mentioned last quarter, with the charges being more heavily weighted towards the first half of our fiscal year. We will provide further updates to the restructuring expectations as we move through the year. Adjusted EPS was $1.53, and GAAP EPS was $1.25 for the quarter and included restructuring, acquisition, and other charges of $0.28. The adjusted effective tax rate was approximately 20% in Q1. And for the second quarter and for the full year, we expect our adjusted effective tax rate to be approximately 21%. And as always, importantly, we continue to expect our cash tax rate to stay well below our adjusted ETR for the full year. Now let's turn to Slide 9. Sales of $3.8 billion were up 1% reported and up 8% on an organic basis year-over-year. Currency exchange rates negatively impacted sales by approximately $300 million and adjusted EPS by $0.21 versus the prior year. In the second quarter, we expect currency exchange rates to be a headwind of approximately $165 million year-over-year. And last quarter, we indicated that foreign exchange would negatively impact full year sales by approximately $1 billion year-over-year. We now expect the full year impact to be roughly half of this number at the current exchange rates. Adjusted EPS was $1.53 and adjusted operating margins were 16.2% as we expected. Now turning to cash flow, in the quarter we once again demonstrated the cash generation model of our business with cash from operations of $581 million, free cash flow was approximately $400 million, and we returned over 100% of our free cash flow to shareholders through share buybacks and dividends. We continue to remain disciplined in our use of capital, and our long-term strategy remains consistent. And as you know, that is to return two thirds of our free cash flow to shareholders and use one third for acquisitions over time. Before I turn it over to questions, let me provide a quick recap. The strategic positioning of our portfolio enabled us to deliver Q1 sales and adjusted EPS that exceeded our guidance. From a market perspective, the Transportation and Industrial segments are consistent with our view 90 days ago. We continue to benefit from content growth in Transportation and continued market recovery and growth in the Industrial segment. However, some of this was offset with cyclical weakness in communication end markets and the inventory adjustments that come with that. We continue to execute on our margin journey and you can see that progression in the Industrial segment. We remain focused on the actions that we can control, implementing price increases to offset inflation and driving additional structural cost reductions to improve our margin performance as we go forward. We continue to demonstrate our strong cash generation model, with strong balance sheet that can support investments for growth. We will balance the short-term pressures with long-term opportunities, and I'm very excited about the opportunities we have to drive long-term growth, margin expansion, and value creation for our customers, employees and shareholders. Let's now open up for questions. Hey, good morning guys. Thank you very much for taking my questions. Could you please provide more detail on orders, specifically the linearity of how orders tracked over the course of the quarter and into January and any differences in order trends by end market? Sure. Thanks, Mark. Thanks for the question. First off, how orders trended during the quarter and even into January had been pretty stable outside -- except for our Communications segment. So when you think about orders linearity or orders were stable, except for the one area that we highlighted. And what's interesting is, and you see it on the orders chart, our backlog in both TS and IS are up year-over-year. We have seen our backlog being worked down in TS, and it reflects the demand dynamics that we see. So from a demand, I think you got to look at both orders and the backlog together to really get a picture. If you break it apart by segment, as I said on the call, Transportation, if you remove currency effects, our orders were up 9% year-over-year. And production has been running around this 20 million units per quarter. So relatively, it's got more stable, and the supply chain has improved. And really, that growth really comes into the content that you see the strong outperformance and that we've, I think, proven to you about our content opportunity. In Industrial, we continue to benefit from some markets that are recovering. You see that Comm Air, while single aisle is back very -- back to pre-COVID levels, dual aisle aircraft, which are bigger content opportunities for us are starting to improve. So we still see recovery there. Also in medical, we see it. And in those two markets, we still see some broader supply chain challenges, but we see our orders continuing to accelerate there and renewables I talked about as well. The only place in Industrial, I would highlight, we had multiple years of very strong growth in our industrial equipment business. We probably see that plateauing. It would probably be how I would phrase it because that growth is just off a very high base, and we're going to have tough compares. And in Communications, where we really saw the weakness, I would say, we always highlighted to you that the appliance business that we had was going to benefit in cycle due to the COVID benefit it got. It's playing out as we expected where it got worse was in communications, where we were expecting moderation in cloud CAPEX spend. We solely got weaker both in enterprise and telecom type applications. And that supply chain is here, let's face it, whether it's distributors selling into EMS or lower-tier players or the ODMs and EMS. They all make the same, and what we are experiencing is we do see inventory burn happening there. So I think it's more of a cyclical element we're dealing with. And as you go through inventory burns, as I said on the call, that's going to be with us for at least a couple of quarters, that's going to have a cyclical pressure with us in communications. Hey, good morning and thanks for taking my question. I wanted to follow up on the Communications Solutions segment discussion. I was hoping you could provide a bit more color on the progression of comms demand throughout the quarter? And then can you give us a view or sense into how you're thinking about sequential 2Q sales and margin trajectory for the segment? Thank you. Sure, David. Thanks for the question. And I'm not going to repeat what I said in the last question on the demand side. But as you think about our comm segment, last year, pretty much every quarter, it ran in excess of $600 million and really showed the momentum we have in those applications. In the first quarter, it's down to 520. When we look at where we see the demand levels, we think that we're probably going to be around $450 million to $500 million in revenue in the second quarter. So we do expect an incremental step down with what we're seeing in demand patterns and this inventory work off. And then right now, with the best we can tell, that's probably where we're going to stay for a couple of quarters. So that's how I think you should think about it. I do think what you'll see from a margin perspective is I think we've done a great job proving to you what we've done with the cost base of this segment when you saw the margin outperformance last year. But I do think you'll see this in the mid-teens as we work through this and working its way back up as the inventory works up into the higher teens as we work through the year. Yes, thank you. Good morning. Terence, can you just help us with some color around margins in your other segments as well, particularly, you stressed confidence in moving industrial back to high teens and also recovery in transport margins. How much of that is predicated on some of these restructuring actions versus the pricing initiatives that you've taken in transport and how contractual are those or is there a lot of cyclicality or uncertainty associated with accomplishing those initiatives? Wamsi, this is Heath, and I'll take the question. First of all, if you just take a step back for a second, our margin targets for each of the segments is unchanged. I mean we will react to different types of market conditions in terms of the demand environment, as you would expect us to. But in terms of how we focus some of the cost reduction and footprint consolidation efforts, those strategically are unchanged. Now we've accelerated some things, and you've seen that more recently in some of the charges that we've taken. And some of that is in response to a quicker decline in the communications business than what we had originally anticipated. But if you just break it down by the three segments, and they each have a little bit different story, the transportation margins we've talked to you about, there's been a lag from -- when we felt the inflationary pressures and continue to, and we feel those real-time versus when we can get the negotiated price increases in effect. And those are meaningful price increases, and we're confident that we are in the -- as we implement those real time, that those are going to have a nice benefit for us as we work our way through the year and would expect the Transportation segment margins to be in the high teens during the second half of fiscal 2023. The Industrial business, we're pleased with the performance. As you see in the quarter, not just year-over-year expansion, but as we continue to move forward, we've been committed to a high teens margin trajectory for the Industrial segment. That has been a balance of both restructuring and growth, and you'll continue to see us move our way through that and hopefully appreciate the progress that you see reflected in our Q1 results accordingly. And then Communications is a bit of the wildcard right now. Obviously, the prior couple of years, you saw the types of margins that can kick out at the types of volume levels that we were seeing. And as Terrence mentioned, if you go back and look over the last year plus, our communications business was running well north of $600 million a quarter in revenue. And as we go into a period here, as there's some inventory corrections and so forth where we see the revenue being somewhere in that $450 million to $500 million range for the Communications segment, as Terrence mentioned, there will be a deleveraging impact we will get after the cost structure, as you would expect. Our long-term margin for this business is still around 20%, but we're not going to be able to react in one quarter to be able to preserve that. So I think Terrence just mentioned it, and I'll mention it again, if you're modeling it, I'd say the Communications segment will be in the mid to high teens from a margin perspective this year as we deal with the decline. But importantly, all the areas that we are focused in and all the platforms that we have won relative to the areas that we're excited about have very good margin opportunities as we move forward. So we are confident in the overall margin projection there. Thank you. I know the company is only guiding for the March quarter, but I wanted to ask a little bit about the outlook for the various end markets into the back half of the year. And then specifically for auto, I know the company said last quarter that there was agreed to price coming into effect in January. Is that not really having an impact until the back half or are you going to start to see that in Q2? Thank you. Thanks, Chris. Let me talk on the first part before -- thanks Chris, sorry about that. Let me talk about the first part before I get to your price question. Like you said, I'll give you some insights that I think I said in the script around how we think markets could develop. We are only guiding for one quarter. And so in transportation, while I think there's a couple of key points as we think about these markets, I think we've said very clearly that we expect production to be flat. I also think it's important to highlight, we're still well below pre-pandemic levels in auto production. So while it might be around 80 million units a year and flat versus 2019, that's -- there were 88 million cars made in the planet. So we're still below pre-pandemic levels by about 10% on production. When you look at this year, it's all going to be about our penetration in our global leading position in electric vehicles. And what we get excited about is that position, I said on there, if electric vehicles and plug-in hybrids get up to about 25% of that 80 million units, our revenue -- or auto revenue this year, the amount around electric vehicles and plug-in hybrids, will be well in excess of $2 billion of our revenue in automotive. And I think we've proved the content story there. We continue to prove it, and you see it in the outperformance. Looking at outside of automotive and transportation, commercial transportation, last year was a negative market for that -- those submarkets. This year is probably going to be flattish with anything going on in North America and Europe being offset by China weakness, and we'll slightly outgrow that due to our content momentum. In Industrial, I already covered Comm Air, and medical are recovering markets so we expect that you're going to continue to see further growth in these markets because it's how we're catching up. And then there's also levers of further growth potential, especially when you get into Comm Air and dual aisle aircraft, which are only at 50% of pre-pandemic levels. And renewables, that momentum continues. So I really don't view that's going to slow, and that's up to 25% of our energy revenues related to renewables. And in Communications, I think we spent a lot of time on already about how you should think about that market from here as well as maybe where the revenue can be. On the second part of your question around pricing, in the first quarter we were with our customers. And our pricing in automotive, it does lag. When we get inflationary pressures, inflation doesn't stop. We have negotiation with our customers, and we did an additional round in the December quarter, which were negotiated, and now they are starting to come in. They do phase in into the early part of calendar year. And we will get margin improvement in transportation this quarter, in the second quarter from the first quarter, and then it will continue to increase as we go through the year. So those have been negotiated, and we're going to start seeing the benefits of those as they come in as we work through this year. Yes, thanks, and good morning. Heath, I wanted to just ask about your inventory levels. I know last quarter, you talked about some margin headwinds due to reduction in your own inventory within transportation. It looks like your actual inventory dollars were up quarter-on-quarter. So could you walk us through that inventory picture? Thanks. Yes. Sure, Matt. Thanks for the question. And honestly, it's fairly straightforward. And we normally grow inventory in our fiscal Q1 rather than what we're talking about today in anticipation of things specifically related to activities in China, in anticipation of the Chinese New Year. So if you think about the increase we had from sequentially within the quarter, about half of that was just the revaluation due to foreign exchange. And the other half was the planned inventory build that we anticipate. As you think about it for the year, I -- we'll continue to be aggressive. I do not anticipate -- and when you look at -- when we sit back and look at this at the end of the year, that we're going to have a material inventory inflation. Obviously, we'll do what we need to do on the communications side as we deal with everything Terence has talked about already. And then the other two segments are well on plan for that. So hopefully, that answers your question. Thank you. Your transportation content story is very positive and compelling. So congratulations on that. One concern we get though is given a recession or a slowdown and the economy concern, is there any signs of auto unit you mentioned flat outlook, but a potential inventory correction there or a slowdown there as we progress through 2023? No. Thanks Jim for the question. And what we continually monitor with our customers is really how's inventory to the consumer. And when we look at that inventory, Jim, North America is still in the mid-30 days, which is well below the 60 days, which is more traditional. Europe is pretty much in line and China is in line. So we continue to monitor that. What's also nice you continue to see the supply chain improving across the world that anything that would be out there in the supply chain is being worked off. So I'll be honest with you, we got to watch it. So certainly, we're in a slowing macro economy, but I do want to also stress again auto production is still 10% below pre-pandemic. So I don't think we've overshot, but I think we have to keep an eye on it. And I think flat is the way we're seeing it is a prudent way that we've been planning our business right now. Thanks for taking my question. I guess, [indiscernible] kind of have you spent a bit more time on the price increases that you're expecting on the transportation side, how that flows into the model in 2023, can you just quantify what the size increases are that you expect this year? And then secondly, I think the fear I would have is, can you really raise prices on customers, the auto OEMs were actually lowering the price of their own car size by 15%, 20% at this point or do you end up with more sizable pushback, if not for this a likely for next year? So I'd love to just see your perspective on your confidence that these price increases will flow through and what sort of benefit are you embedding from that into your guide for 2023? Yes. So a couple of things, Amit. You were breaking up a little bit, so I hope I get every element of your question. First off, being our pricing with our customers are contractual. So no different than you've seen us have a lag in transportation. I do want to make sure that is around transportation. These are negotiated elements that came in, and we have been, over the past three to four months doing another round, which does give us the confidence around the pricing and those global agreements aren't checked. Now certainly, each one is a little bit different, and they will be coming in. So we will see the benefit of them starting this quarter that we're in, and it will accelerate as we go through the year. And the other element is we're still dealing with inflation. So when you look at it, we are still in an inflationary environment, things that are oil-based, how utilities and conversion costs that come out of some of the materials we use. We're still in an inflationary period, even though it might be a lower rate than last year. And we're still dealing with that in transportation as these prices come in. So as I said on our prerecorded message, we do expect our margin to get up in the high teens in the flat environment later in the year, and that will benefit from the pricing that we put in -- and what we do with our customers, we are a commodity business. We are key to their EV launches. We aren't making commodity products here. And that's the contractual nature of what we do with them. So certainly, they may have some price pressure. Certainly, we've had price pressure, and that's what we had to go through the negotiations, and we do have confidence around them. There's been a lot of talk already on kind of inventories and price and inflation. But can you disaggregate inflation a little bit for us and help us understand kind of -- are you seeing material moderation in things like labor inflation, I mean we can follow the materials ourselves, but labor is something that I think is a little bit harder to track? Yes, Scott, I think it's important when you look through that in our world, material is the biggest part of our spend when you look through it. Labor is incrementally higher, but the bigger pressure that we have is really around the base materials we use. And during this period, you cover it well, you really have not only the base material, but then you also have where do utilities and conversion costs come in. And where I would say we're still seeing inflation metals have come off, I would say it's more neutral year-over-year. In resin-based things and chemicals, where you use a lot of energy to make those and let's face it, some of that those come out of Europe, continuing to see inflation there. Utilities around the world, certainly, the cost to run factories is inflationary. And the other area that I would say we talked about that actually has retreated is around how do you move things around the planet from a freight and logistics perspective. So last year, you would have had everything inflationary. You're seeing freight logistics come down. You're seeing metals be more neutral, but you're still seeing resins and oil-based things that are energy-intensive still have an inflation around it. Labor for us is incrementally inflationary, but I wouldn't say it's the biggest headwind we have, and that may be different for other companies. Hey, thanks. Good morning. Just shifting gears a little bit. I was curious about the Industrial segment margins, incrementals were a few hundred percentage points. And you held margins on lower sales versus the second half of last year. So I'm curious if you're hitting more of a culmination of the cost structure program that you've been talking about for a while? Hey Chris, it's Heath. It's a good question. It feels like we're always on this journey with Industrial. I would say that, certainly, we're pleased with the results in the quarter. And as we look through the year and our internal viewpoint, certainly, there's progress being made. Now the other thing, and there's a lot of good reasons, but we do -- this is -- this does tend to be the segment that we are the most acquisitive in. And we have done enough acquisitions last -- in the last couple of years, where we feel, at least 100 basis points of margin pressure just from those acquisitions. But that's part of the value creation journey, right? We bring something in. We know it's lower margin. We get the cost structure right. We integrate as appropriate, and then we start to see the returns from overall. So absent that impact, I feel very good about where we are from the restructuring journey we've been on, which is really a flip top -- or I'm sorry, a rooftop consolidation journey that we've been talking pretty publicly about for the last five years. We have made a ton of progress on those rooftop consolidations. And then just the acquisitions are the things that are kind of the wildcard in here in terms of the pressure relative to the opportunity. Sometimes, we don't get into that as much, but it was pertinent to your question. I thought I'd highlight that, Chris. Great. Thanks for taking my question. You just answered a bit of this, but I'd like to dig a little bit more into the M&A opportunity. You highlighted that the company plans to spend over time about a third of its free cash flow on acquisitions. I think it's been significantly below that level for several years. So I'm hoping you can maybe refresh our memories as to both the strategic and tactical approach to M&A and whether we might expect that to accelerate in the next couple of years given the spend has been, I think, quite a bit below that third of free cash flow number? Thank you. I appreciate the question. And certainly, the two thirds, one third ratio that we talked about and have talked about for years is through a cycle, right. You're going to have periods of time when you do acquisitions and it's heavier or size of a deal tends to swing you in a particular direction. I would tell you that there's been times over the last couple of years where we have not spent that third. At the same time, that doesn't mean we're not active in the space. I think, so far this fiscal year, we've spent about $100 million on a transaction. So we're -- I don't know what that is in terms of our ratio, but you can't look at it in really quarter-by-quarter or even in a one-year off basis. We do have a pipeline of activity. And as you imagine, besides the stuff that we keep track of and we monitor and cultivate on our own, we obviously are involved in a lot of processes that are out there as well. However, our approach to this is unchanged. That means the deal has to be strategically important for us, number one. Number two, where do we add value as the owner of that company. And then number three, obviously, the financial profile of the acquisition and how it relates to what's good use of cash for our owners. So we're going to continue to be disciplined in that process. We're going to continue to make sure that we're making smart acquisitions and in spaces that we feel very good about. So there is some fragmentation out there, and it just depends on which of our business units. And we'll continue to be aggressive in those areas, and we'll see where it all adds up here as we track it over time. Good morning. This is Michael on for Joe. Earlier, you mentioned elevated restructuring costs in the first half of the year, which are more in line with 2020 levels. Can you disaggregate the drivers behind that, I know you had mentioned a little bit earlier, but any additional color would be super helpful? Yes. And Michael, I appreciate the question. As you think about it, when we went into the year, we said restructuring will be roughly flat or down from the prior year. And prior year FY 2021 number was around -- I'm sorry, FY 2022 number was around 150 million. Certainly, that was our plan going into the year, with the incremental downturn, particularly in the Communications segment. We have elected to accelerate some things in order to react more aggressively to that, which will push our FY 2023 number higher. I'm not at a point right now where I want to quantify exactly how much higher it is. We'll have a better view when we're back online here in April. But I would say that it's -- we took a charge in Q1 of north of $100 million that we've already spent a good chunk of that, and that was really to aggressively get after a few things here. Longer-term, certainly, after we react to that, we would anticipate bringing this number down. And our hope was to do some of that in 2023. But with the market conditions, that's not going to happen. Hi, thanks for taking my question. I guess I wanted to see if I can dig into the industrial equipment sub segment a bit and get some more color there. You talked about the recovery that you're seeing in medical, Comm Air and also the strength in renewables. But when I look at the industrial equipment, the broader sort of industrial group there, how are you -- what are you seeing in terms of the impact of macro, what are the puts and takes there, and any sort of color on book-to-bill, what that sort of sub segment is tracking at? Yes. So first off, when you look at it, I would tell you, I do think we have to keep in the context our industrial equipment business grew 25% each of the last two years. So very strong growth. And I think what we're seeing is we continue to see the backlog around CAPEX whether it's around what you see around automotive, electric vehicle, those types of things, that backlog is very strong. We are also seeing supply chain improving. So in that space, you're seeing supply chain improving. So that will impact order levels a little bit, but not to the extent we're seeing in Communications. The other thing that I think we're watching is, it's not lost on us, what's happening in consumer electronics. Consumer electronics is a big user of factory automation. And that certainly has been a weakened market. What happens around warehousing could be a weaker environment as well. So when we look at that, there are areas, but there are strength areas when you think about the infrastructure investment as well that our products go into. And you're also seeing strength in process automation. So I would tell you, it's not all in one direction. I think it's also -- we have tough compares that we're going to be going up against. And it feels like we've seen a peak and plateauing is how we would see it both from an orders as well as the supply chain improves. Hi, good morning. Just one broad question on China and there's been a lot of news flow out of there and questions around how companies manufacturing footprint should look for the long-term or even shorter term given all the changes in terms of government policies, et cetera. Can you just sort of sum up your current situation in China and then how you look at sort of your global footprint, especially as you do some restructuring down the road here? Thanks. Sure. Thanks, Steve. And a couple of things, I mean you followed us for quite some time now, and we've always been on that how do we produce engineer where we make if we can? And our China footprint is very much for China. We are not a big exporter out of China, and anywhere we even do have that, we do continue to look at where do we have China plus one within region where we might be doing some things for Japanese or Korean customers in China, they may want an option. So I view it much more as a modification and an evolution than a wholesale change because we don't import a lot of things back to places like the United States. We're also -- when you think through our growth opportunity, we talk a lot about electric vehicles. China is the largest electric vehicle market. So we continue to look at how do we expand capacity in China to support those local OEMs as they continue to make up the lion's share of electric vehicles. So net-net, our strategy to move back again to the big picture we want to manufacture in region, it's the best for the supply chain. Certainly, we have to mirror what our customer supply chains are, and you're going to continue to see us modify so that we make within region. And even some of the things Heath talked about in restructuring is, in some cases, we're still exporting out of places like Europe into China. We want to make sure we're more localized in China. So we're continuing to invest in China around these key verticals that we expect to be there long term and drive our growth. Hi, good morning. Just want to understand, sorry if this has been covered already, but I want to understand that the transportation margins just a little bit better. So I think you guided to, at the last quarter, at least 100 basis points of impact on the Transportation margins for the inventory reduction. At the same time, you also benefited in this quarter from, I believe, very strong pricing as well as strong outgrowth driven by mix. And even if I take out that 100 basis points of inventory reduction impact, you're still like 100 to 140 basis points decline in the margin despite the pricing. So does the pricing get even stronger as the year progresses, is that kind of what you're communicating, can you help me understand that a little better? Sure. Guy, this is Heath. We covered some of this a little bit earlier, but our price increases largely are a little more calendar-focused, if you think about it and go into effect really as we sit here today. So January-ish time frame, they're obviously not all aligned on the same date, but more or less, we didn't see much help in our first quarter results in transportation or otherwise from pricing. So it pretty well laid out as you would have thought in terms of that. Now as we work our way through the year, both in the quarter as Terrence mentioned earlier, both in the quarter and the second quarter that we're sitting in today as well as our second half of our fiscal year, we do expect a significant help from those pricing increases. And you'll see those -- I'm confident you'll see those in both our second quarter results as well as the back half of the year. Good morning, thanks for taking my question. A modeling question for me. Heath, just wondering if you can help us understand the moving pieces around your updated FX guidance, specifically, how that translates from revenue to earnings, wondering what has changed versus 90 days ago in terms of how it works through the plumbing, if you will, especially thinking about the back half of the year and the earnings impact as the top line impact starts to moderate? Sure, Luke. And listen, it's been a moving piece for us as well over the past 90 days. The top line piece is really just we snap a line in the sand in terms of where things are relative to the dollar. And we did see the dollar weaken in the quarter, particularly towards the end of the quarter. And obviously, that's impacting most all companies who are global. That's the translation impact. The transactional impact is a little bit harder because that starts getting into where we denominate currency versus where we have costs and those types of things and where we move things across border, across currencies. And so that piece of it has more of an impact to the EPS element of it. Now we talked last quarter about $1 billion, and most of that first -- $1 billion year-over-year and most of that in the first half weighted. Now it's about half of that at today's rates, and that's still largely in the first half of the year. And you see the numbers we talked about, the $300 million year-over-year impact in the first quarter and $165 million that we just guided for the second quarter in terms of that, and I think we provided in the bridges, the EPS elements of that. Now at today's rates, if you work your way through the back half of the year, it balances itself out. You don't have much of an impact in the back half of the year. A little bit of a headwind I think in the third quarter, and it swings around a little bit of tailwind in the fourth quarter, but we're getting into much smaller numbers at that point. So the back half, again, at today's rates, we don't know what's going to go from there. That's kind of how it looks. Hey, thanks so much for taking my question. Just coming back to communications. So maybe thinking a little bit beyond this year. You've talked about the ability to sustain low 20% margins in that segment. Obviously, we're going to be dipping below that for the next few quarters, but I'm just trying to get a sense of the bridge to get back to that low 20s level, I mean how much of that is really dependent on the end markets versus some of the internal cost actions that you're talking about taking out? Sure. This is Heath. I'll take this. It's really -- I mean, listen, I think if you look at your models, first of all, it's our smallest segment, right? So there's a little bit of law of small numbers here on a relative basis for TE when you start getting to the margin rates. And we are always very careful about not jumping up and down to when we had the real high margins the last two years because we knew what the leverage was in those factories when you have that kind of output and when you see it flip around. So when you go from a 600 million to 650 million per quarter run rate at that segment down to sub 500 million here for the next few quarters, it does have a meaningful impact. And I think part of it also is the amount of inventory bleed off. And the margins that we know exist in that channel inventory that's just the reality of the cyclical nature of this. Now our confidence, in terms of being able to get back to closer to a 20% margin number for the segment, really resides in the fact that we don't -- we see this as more than a $2 billion segment annually, right. We do see this continuing to grow. We know the markets where they are. We know where our customers' capital needs are and the things and the platforms that we've been specked [ph] in on that are incremental growth to us going forward for the next several years. We feel good about that, and we know what the margin is going to look like, but we're going through a bit of an air pocket here for the rest of 2023 or for at least the next couple of quarters of 2023. Okay. Thank you. We'd like to thank everybody for joining our call this morning. And if you do have additional questions, please contact Investor Relations at TE. Thank you and have a nice day. Ladies and gentlemen, today's conference call will be available for replay beginning at 11:30 A.M. Eastern Time today, January 25th, on the Investor Relations portion of TE Connectivity's website. That will conclude the conference for today.
EarningCall_1489
Welcome to the U.S. Bancorp Fourth Quarter 2022 Earnings Conference Call. Following a review of the results, there will be a formal question-and-answer session. [Operator Instructions] This call will be recorded and available for replay beginning today at approximately 11:00 A.M. Central Time. I will now turn the conference call over to George Andersen, Senior Vice President and Director of Investor Relations for U.S. Bancorp. Thank you, Brad and good morning everyone. With me today are Andy Cecere, our Chairman, President and Chief Executive Officer; and Terry Dolan, our Vice Chair and Chief Financial Officer. During their prepared remarks, Andy and Terry will be referencing a slide presentation. A copy of the presentation as well as our earnings release and supplemental analyst schedules are available on our website at usbank.com. I would like to remind you that any forward-looking statements made during today's call are subject to risk and uncertainty. Factors that could materially change our current forward-looking assumptions are described on page two of today's presentation, in our press release, our Form 10-K, and in subsequent reports on file with the SEC. Following their prepared remarks, Andy and Terry will take any questions that you have. Thanks George. Good morning everyone and thank you for joining our call. I'll begin on slide three. This quarter, we completed the acquisition of MUFG Union Bank on December 1st. In the fourth quarter, we reported $0.57 per diluted share or $1.20 after adjusting for notable items related to the acquisition. This was a complex quarter that included one month of Union Bank results, merger integration charges, and balance sheet optimization activity. Terry will provide more details on these notable items. Importantly, we ended the year with a common equity Tier 1 ratio of 8.4%, which was just above our expected level at deal close and we delivered positive operating leverage for U.S. Bancorp legacy operations of 230 basis points for the full year. Strong year-over-year pre-tax provision income growth as adjusted for notable items was driven by net interest income growth and positive operating leverage. Credit quality remains strong, although credit metrics are starting to normalize as expected. Slide four details are reported and adjusted income statement results as well as end-of-period balances and other performance metrics. End-of-period assets for the company totaled $675 billion, reflecting the acquisition of Union Bank and certain balance sheet optimization actions. Slide five highlights key performance ratios. This quarter, we delivered a return on average assets of 1.2%, a return of average common equity of 16.8%, and a return on tangible common equity of 23.4%, each as adjusted for notable items. Turning to slide six. The completion of the Union Bank acquisition marked a significant milestone for our company. With double-digit percent increases in loan and deposit balances, Union Bank adds meaningful scale to our business that enables us to better serve our customers and communities. Union contributes considerable small business and consumer market share in a demographically attractive California market, and we're excited about the potential to deepen existing Union Bank relationships by overlaying our leading digital capabilities and robust product set, including wealth management, consumer and business banking and payments offerings across a loyal but under-penetrated consumer base. In many ways, this deal underscores our commitment to creating a stronger, more competitive regional banking organization in a rapidly evolving environment. One of the more attractive aspects of this transaction is Union Bank's high quality, low cost consumer deposit franchise, which will support continued loan growth and margins. Thanks, Andy. If you turn to slide 7, as Andy mentioned, we reported diluted earnings per share of $0.57 for the quarter or $1.20 per share after adjusting for notable items related to the acquisition. Notable items related to Union Bank acquisition are comprised of three primary elements that reduced earnings per share by $0.63 related to balance sheet optimization, merger and integration costs, and the impacts of -- on provision expense related to acquired loans and actions taken to optimize the balance sheet. During the fourth quarter, the company recognized a one-time $399 million pre-tax loss on a net basis related to several actions taken to optimize the balance sheet, manage the interest rate volatility impact on capital levels and position the company for future growth. Subsequent to obtaining regulatory approval for the transaction, we entered into interest rate hedges to manage rate volatility and its related impact on regulatory capital from the date of approval through the closing of the transaction in December. During that time frame, long-term interest rates increased nearly 50 basis points before declining approximately 65 basis points. The interest rate swaps were terminated at the time of closing, and the losses recognized through earnings largely offset the interest rate marks recorded into the balance sheet through purchase accounting. In addition, the company optimized its balance sheet by selling certain loans and repositioning its investment portfolio on certain equity investments. Within non-interest expenses, we incurred merger and integration related charges of $90 million that primarily included the impact of specific deal closing costs, professional services and employee related expenses. We also incurred a $791 million charge to the provision for credit losses, which reflects an initial provision impacted by the acquisition of $662 million and a net loss of $129 million related to the securitization of approximately $4 billion of legacy indirect auto loans. Again, these moves enabled us to more effectively position the balance sheet for profitable growth and optimize returns. Slide 8 provides a more detailed earnings summary. Union Bank, which was included in our consolidated results for one month, contributed $302 million of revenue, $221 million of non-interest expenses, $81 million of operating income and $44 million of net income to the company, representing $0.03 per diluted share. On slide 9, end of period loans increased 13.3% on a linked-quarter basis to $388 billion, which included core loan growth and acquired loans from Union Bank. Union Bank contributed ending loan balances of $54 billion net of purchase accounting adjustments, partly offset by a reduction in balances of $15 billion related to balance sheet optimization actions, including loan sales and securitizations. Slide 10 provides end-of-period deposit balance composition. End-of-period deposits increased 11.4% on a linked-quarter basis to $525 billion driven by the acquisition, which contributed $86 billion of lower-cost deposits, and actions taken as a result of the deal to optimize our funding sources. On a core basis, we saw deposit balances decline slightly this quarter. Turning to slide 11. The investment securities portfolio grew 4.2% linked quarter to $170 billion. The addition of securities from Union Bank were offset by balance sheet optimization actions. Slide 12 highlights revenue trends. Adjusted net revenue totaled $6.8 billion in the fourth quarter, which included revenue contribution of $302 million from Union Bank, primarily representing net interest income. For legacy US Bancorp, net interest income grew 5.5% on a linked-quarter basis and 29.2% year-over-year driven by strong earning asset growth and net interest margin expansion, which benefited from rising interest rates. Results were partially offset by higher deposit pricing and short-term borrowing costs. Non-interest income, as adjusted for the legacy company, declined 3.0% compared to the third quarter driven by seasonally lower payment service revenue and lower commercial product revenue, offset by stronger mortgage banking revenue. Year-over-year, legacy adjusted non-interest income declined 5.5% driven by lower mortgage banking revenue from reduced refinancing activity and lower servicing charges, offset by stronger payment services revenue and trust and investment management fees. Turning to slide 13. Adjusted non-interest expense totaled $4.0 billion in the fourth quarter, including $221 million from Union Bank. Included in expenses was approximately $42 million of intangible amortization due to core deposit intangibles established at the time of the acquisition. Legacy non-interest expense, as adjusted, increased 3.8% on a linked-quarter basis largely driven by higher compensation-related expenses as well as higher expenses related to professional services, marketing, technology and tax credit amortization. Slide 14 shows credit quality trends. We reported total net charge-offs for the quarter of $578 million. After adjusting for acquisition impacts and the balance sheet optimization activities, net charge-offs totaled $210 million or 0.23% of average loans, up from 0.19% in the third quarter, which reflected the continuing normalization of credit losses. Non-performing assets for the legacy bank increased slightly, while Union Bank contributed $329 million to the total. On a combined basis, the reported ratio of non-performing assets to loans and other real estate was 0.26% at December 31, compared with 0.20% at September 30, and 0.28% a year ago, reflecting a continued strong credit quality. The provision for credit losses was $1.19 billion, which included a provision of $791 million related to the acquisition and balance sheet optimization activities. This provision includes an initial provision impacted by the acquisition of $662 million and $129 million related to our balance sheet optimization activities. The allowance for credit losses as of December 31st totaled $7.4 billion or 1.91% of period-end loans, which reflects increased economic uncertainty and the incorporation of the Union Bank portfolio. Slide 15 highlights the drivers of our linked-quarter common equity Tier 1 capital position. As of December 31st, our CET1 capital ratio was 8.4%. Acquisition impacts of 180 basis points included an increase in goodwill and other intangible assets that reflected the impact of credit and interest rate marks, the initial provision for credit losses, balance sheet optimization actions, as well as the increase in risk-weighted assets with the addition of Union Bank. These impacts were partially offset by an increase to equity related to shares issued to MUFG as part of the purchase price of Union Bank. Slide 16 provides our current expectations of certain financial metrics related to the transaction. The financial and strategic merits of the deal remain intact and are very attractive. Earnings per share accretion is now expected to be 8% to 9% in 2023, which is higher than originally estimated. While our tangible book value per share dilution is higher than initially estimated due to the significant impact of rising interest rates on the interest rate marks at close, our estimated earn-back period is only slightly longer than our original estimate at two years versus our original estimate of 1.5 years. Slide 17 provides a comparison of credit and net fair value marks from the time of our announcement to closing. Credit marks are lower due to favorable changes in portfolio composition and credit quality, partially offset by economic deterioration. Interest rate marks, inclusive of loans, securities net of sales, and debt, are higher than anticipated at announcement due to higher interest rates, but we expect that to accrete quickly back through earnings. The core deposit intangible is also higher than originally estimated, reflecting the increased value of lower-cost core deposits in a higher rate environment. I will now provide first quarter and full year 2023 forward-looking guidance, which is provided on slide 18, starting with the first quarter 2023 guidance. We expect average earning assets of between $605 million and $610 billion in the first quarter and the net interest margin that is five to 10 basis points higher than the fourth quarter level. Total revenue is estimated to be in a range of $7.1 billion to $7.3 billion, including approximately $100 million of purchase accounting accretion during the quarter. Total non-interest expense as adjusted is expected to be in the range of $4.3 billion to $4.4 billion, inclusive of approximately $125 million of core deposit intangible amortization related to Union Bank. Our income tax rate as adjusted is expected to be approximately 22% to 23% on a taxable-equivalent basis. We anticipate merger and integration charges of between $200 million and $250 million for the quarter. I will now provide guidance for the full year. For 2023, average earning assets are expected to be in the range of $610 billion to $620 billion with net interest margin expansion of between five to 10 basis points compared with the fourth quarter of 2022. Total revenue is expected to be in the range of $29 billion to $31 billion, inclusive of between $350 million to $400 million of full year purchase accounting accretion. Total non-interest expense as adjusted for the year is expected to be in the range of $17 billion to $17.5 billion, inclusive of approximately $500 million of core deposit intangible amortization related to Union Bank. Our estimated full year income tax rate on a taxable equivalent basis as adjusted will be approximately 22% to 23%. We expect to have $900 million to $1 billion of merger and integration charges in 2023. Thanks, Terry. We accomplished a lot this past year, including the completion of the Union Bank acquisition and a strong legacy PPNR growth supported by positive operating leverage on an adjusted basis. Union Bank adds significant scale to our business and deepens our commitment to serving customers and creating economic opportunities for communities across the West Coast. We continue to target a Memorial Day weekend systems conversion, incorporating a lift-and-shift approach to our applications, which mitigates risk and allows us to more quickly capture meaningful cost synergies. There is still a tremendous amount of economic and geopolitical uncertainty, and we are preparing for any scenario. I believe we will perform well because of the strength of our business, a strong balance sheet and the great team we have. As we've proven during previous economic downturns, our business model is resilient and recession ready in large part due to our disciplined through the cycle credit underwriting standards and robust risk management infrastructure. Our consumer clients are predominantly prime, super prime, and our commercial book is generally investment grade, and we have very little leverage lending commitments. We are focused on prudent balance sheet growth, high return, high margin opportunities and the prudent allocation of capital to lines of business and products best served to deliver on our strategic objectives. Our growth strategy is focused on creating value for our customers, communities and shareholders, which allow us to generate industry leading performance. Let me close by saying thank you to our 77,000 employees across the company, including our newest colleagues from Union Bank. Your dedication and commitment are what make US Bank special and the destination of choice for all the constituents we serve. We'll now open up the call for Q&A. We will now begin the question-and-answer session. [Operator Instructions] And we can first go to Scott Siefers with Piper Sandler. Please go ahead. Maybe a question for you. Just at the top level, was hoping you could speak to what balance sheet and capital management will look like for you. So you're still under $700 billion in assets. But any thought on limiting growth, or will there be additional sales or securitizations to help keep you under there? And then, I guess, on repurchase, I know we're on pause until we get back to the common equity Tier 1 target. But with the looming category move up, would there be any thought to hold off longer than that just to sort of see what happens? Just any thoughts on either of those would be great, please. Scott, I'll start. This is Andy and Terry will add in. So first of all, we're not limiting growth in the company. We – one of the reasons we positioned the balance sheet and took the optimization actions we talked about, Terry went through, was to allow for profitable growth. It also was related to the credit box that we manage within as well as the returns that some of those categories of assets that we securitized were returning. So those are all allowing us to grow in a profitable way in the future. As we talked about before, we not expect to cross the threshold of a Cat II until the earliest at the end of 2024, and that's into the new category at that time. And if we have any further balance sheet optimization actions in securitizations, they would be very nominal and not material in nature. Terry, what would you add? Yeah. No, I would just again reiterate, we're ready to be able to adopt Category II by the end of 2024. But there's no real cap. We wouldn't expect any real significant balance sheet optimization from here. And we spent a lot of time positioning the balance sheet for growth as we go forward. Wonderful. And then just sort of thoughts on repurchase as well? I know, we're on pause for now, but it's still sort of a crush mark, so would be curious to your thoughts? Yeah, Scott. So as we've said in that, we continue to expect that. We are starting about a good spot, about 8.4% CET1. We expect that to creep up to at or above 9% by the end of next year, and it continue to accrete 2023 and continue to move up from that particular point. So one of the things, we'll do is once we get to above 9%, we'll have to make an assessment as to all the different things that are happening out there from a regulatory perspective. I mean, you have the regulators looking at Basel III and are having to think about Category II and those sorts of things. But I think it's really going to be based upon what the landscape at that particular point in time looks like. But certainly, in terms of our core CET1, it will create nicely throughout 2023. And thank you for all the detail that you gave us on the slides. My first question is on the cadence of the cost synergies as it relates to your expected Memorial Day weekend conversion. So first clarification question, the 35% cost synergies, is that a target for full year 2023? And what is that cadence like? Do we expect very little in cost synergies until Memorial Day weekend and then an acceleration in cost synergy capture as the systems converge? Yeah, Erika, great question. And just to confirm, our expectation is that of the $900 million of cost synergies, we'll see about 35% of that next year in 2023. And so from a cadence standpoint, with the Memorial Day conversion, the vast majority of those cost synergies will start to really kick in subsequent to that system conversion. So smaller during the first half of the year much more significant of that 35% in the second half of the year. Got it. So the – so in other words, we should anticipate an exit rate by 4Q 2023 of well above 35%? Yes. By the time we get to the end of the fourth quarter, we will have incorporated the vast majority of the cost synergies such that by the time we get to 2024, we will be in a good position to have achieved 100%. Got it. And my follow-up question is on the economic outlook. If you could remind us what is being captured in the legacy U.S. Bank reserves in terms of the GDP and the unemployment outlook. And how are you thinking, based on that outlook, charge-offs for legacy U.S. Bank would trend as we anticipate -- it seems like a lot of your peers are anticipating a mild recession from here. Yes, I would say that our expectations are probably consistent with that sort of a thought process. When we are thinking about the reserve, our base case is that there is a mild recession probably in the second half of the year and that unemployment ticks up and GDP is either relatively flat or down a bit. When we go through the reserving process, as we've said in the past, we end up looking at five different potential scenarios all the way from a base case to a severe sort of recession. And I would say that from a reserving perspective, we're a little bit weighted towards that downside scenario, so a little bit more conservative. From a charge-off perspective, our expectation kind of using the baseline of about 23 basis points in the fourth quarter that, that will continue to normalize throughout the year. We'll see both the delinquencies and charge-offs moving up. But to kind of give you some perspective, our pre-pandemic was at 50 basis points. We probably don't see that until sometime into 2024. Hi. Hey good morning. I just wanted to clarify. So, you made your positive operating leverage in 2022 over 200 basis points. If you back into the numbers, I'm getting positive operating leverage year-over-year all-in of somewhere between, I don't know, 100 to 900 basis points. I'm not sure if that's correct. And if you back in the numbers, what do you get? And why the such big variance in the revenue guide? That's a $29 billion versus $31 billion. And why is the margin still increasing five to 10 basis points in the fourth quarter? That's a bit more of an improvement versus others. I'll start on a couple of things and then Terry will add in. So, let me sort of go backwards on your questions. The margin is increasing principally because of the value of the low-cost deposits that Union Bank brings on. We talked about that a lot, Mike, and $85 billion of principally consumer low-cost, stable deposits in this environment is very valuable in driving up that margin on a quarterly basis. And that's reflected in that five to 10 basis points. We did achieve 230 basis points of positive operating leverage in 2022. We would expect to achieve continued positive operating leverage into 2023. But 2023 is going to have the merger-related charges in it as well. So I'm looking at it on a core basis. And Terry, what would you add? Yes. Just maybe kind of coming back to the net interest margin, we expect see lift related to Union Bank coming on, that five to 10 basis points and then from there, kind of flattish to maybe moderate increase or expansion in net interest margin through the rest of the year. But clearly, deposit betas and things like that are going to accelerate a bit in 2023. And as a follow-up, look, U.S. Bancorp had been a low cost producer for a long time. It looks like you're going to trend back in that direction. So it sounds like you still have no change in expected synergies. I get it, Union Bank is performing better, and that's why the accretion you had brought higher, the 8% to 9%. But still no change in expected synergies from the acquisition? And then separate from that, Andy, you mentioned in December that the big tech investment cycle is now turning positive versus being a drag the last five-or-so years. If you could elaborate on that? Thank you. Sure, Mike. And you're right, we still are projecting, as Terry went through, $900 million of cost savings, 35% in 2023, 100% fully implemented in 2024. Importantly, we have not in the guidance that we provided, provided any revenue synergies. So it's without revenue synergies, which we think there are going to be some particularly after the integration and conversion process. We are past the heavy spend on tech. You're right, we're more of a flat line and starting to gain the benefits of that. And part of the benefit of this transaction is leveraging the investments we've made in the company over the last three or four years to allow us to lift and shift to our technology platform in a very low cost way. So that benefit is driving through the synergies that we talk about. Good morning. So on the credit metrics, I know you indicated that you're starting to see normalization in charge-offs and delinquencies. I want to see if you can elaborate a bit more. In what income cohorts are you seeing the normalization? We're hearing from some of the consumer finance players that they are seeing some normalization impacting -- or moving beyond just the non-prime and low income but into prime and super prime? And also what asset classes are you seeing the normalization most obviously? Is it just on the card side or in other asset classes? Thanks. Yeah. I mean I -- this is Terry. So maybe to address your first question in terms of where we're seeing it and maybe as a reminder, from an underwriting perspective, we focus on prime, super prime really in all of our consumer portfolios. To the extent that we're seeing delinquencies starting to tick up, it's more so in the credit card space. And you're right; it would be probably on the lower bands as opposed to the upper bands at this particular point in time. But one of the things we talked about is that when you look at savings or excess savings from a consumer perspective, they're fairly significant. That is coming down as that's coming down; people are revolving more on their credit cards. And I think it's just kind of a natural progression that we are seeing. And again, starting more with the unsecured and the credit card portfolio, not as much with respect to the other portfolios yet. But as things continue to normalize, we would expect that too. Okay. Thanks. Terry, that's helpful. And then I guess related, how does this development in consumer behavior and your macro assumptions as well, how does that impact your expectations for your payments revenue and your card revenue and merchant processing revenue as you look out through the year, considering the macro dynamics? Thanks. Yeah. So the payments revenues, you saw, still is well above pre-COVID levels. The card spend is 25% above. On a year-over-year basis, we're plus 5%. So spend continues to be strong. The categories of spend are shifting a little bit. And we would expect continued strong spend, but moderating a bit as we go into the rest of 2023 for the reasons that Terry mentioned. But still expect growth but again, probably more moderate in nature as we go forward and the savings level start to normalize and the consumer behavior starts to change. Yeah. And the thing that I would end up adding, John, is that one of the things we've talked about in the merchant processing is that, we think that business is kind of a high single digits and when we look at 2023, that's kind of our expectation for that particular business. Relative to 2022, we anticipate that our credit card revenue or card revenue will strengthen a bit in terms of year-over-year comparisons. And that is primarily because prepaid sales and prepaid revenue, which has been a drag, kind of starts to moderate. And then on the corporate payment card business, we continue to think that that's going to be reasonably strong, certainly high single digits, if not low double digits. And that's – we're continuing to see travel and entertainment recover very nicely in that particular space. So we feel pretty good about the payment revenue trends for 2023. I just want to follow up one on credit. So you talked about consumer. Looking at the CRE slide, just if you don't mind talking – sharing your perspective around the CRE book, if you're beginning to see any softening either in certain markets, maybe California or within the office CRE book, which is about 10% of loans. Yeah. I mean, maybe at a high level, certainly from a CRE perspective, valuations, I think, are moderating to some extent. The areas that we have had probably the greatest focus on if you will, is really office space. And that is really probably as much tied to return-to-office sort of behaviors or patterns. And I think that, that is probably a longer-term sort of structural adjustment that's going to end up happening. We're just going to have to watch it over time. But when we just kind of look at the core CRE portfolio, it continues to perform pretty well from a credit perspective at this particular point. Got it. And I guess, just one separate question around payments. When you think about in your slide, you mentioned about some of the tech investments and partnerships. Just give us a sense of – remind us around competitive positioning for USB, how you're thinking about just market share outlook and from this partnership standpoint, like areas of like secular growth that you see in this business? Yeah. As you mentioned, we've made a lot of investments in tech-led activity, and our tech-led investments have led to that being the principal area of growth for the merchant processing categories. And then on the card side, the partnership's component continues to be an important strength for us and a point of growth as we look forward. So those two areas, tech-led on merchant and partnerships on card, are doing well and it's partly due to the investments we've made over the past few years. And is the strategy there to just build this in-house, or do you see more kind of bolt-on acquisitions within that business? Many of the investments we made are internal investments that we've developed our capabilities and our platforms to allow for different activities and allow for integration with some of the software that the company has used to run their business. We've added as well, as you know, miscellaneous M&A acquisitions that -- you said bolt-ons like Atellic or Bento that add capabilities around the edges. And I think we'll continue to do a little of both as we look forward. Hi Andy, hi Terry, congratulations on closing the deal. Question for you, Terry, on the balance sheet optimization where you guys decided to sell off certain loans that were acquired. Can you give us some color on types of credits were in those sales? And why would they chose -- I know they didn't meet your credit profile, but what was the driver of that -- I mean some of the details of the credit profiles? Yes. Maybe as a starting point, when we thought about the balance sheet optimization, the things that we were thinking about is really repositioning the balance sheet to position ourselves for growth going forward to be able to optimize or improve profitability and looking at profit margins across various portfolios and returns and then the risk profile. So, maybe from a risk profile perspective, we ended up looking at Union Bank portfolios that we end up acquiring, and there were a couple of different areas that we focused on. One is that they had acquired a number of loans related -- or through a lending club channel, if you will. And that was something that we had planned to run off over time originally when we looked at the deal. And we made a decision that when we looked at the kind of the credit risk profile, how it's originated, et cetera, that we thought that taking care of that upfront made a lot of sense. The other area that we ended up selling was some commercial real estate in their particular portfolios in order to be able to kind of bring that concentration down a bit. And then the other areas of optimization was more on the U.S. Bank side. We ended up looking at lower-margin indirect auto loan portfolio. We securitized about $4 billion associated with that particular portfolio. And then the other things that we ended up looking at in the C&I book of business and across kind of our corporate space is just relationships that maybe had lower returns associated with it, where we could optimize that. And so we allowed some of that to run off, so to speak, during the quarter. And those were the primary areas of focus with respect to the balance sheet optimization. Last thing I would maybe say on the investment portfolio side is that we ended up selling about $15 billion of securities, the vast majority of that coming from Union Bank. And that was really to kind of -- think about it from an interest rate risk perspective, HTM perspective, et cetera. But that was the other area where we did some balance sheet optimization. Terry, where there -- in the corporate loans, were there any shared relationships, meaning you had an exposure to XYZ company as the Union Bank and the total was maybe too much and you guys decided to take that down as well? Yes. Exactly. So, maybe from a risk perspective, looking at hold levels or concentrations with respect to specific customers, yes, that was a part of the strategy. Very good. And then just as a follow-up, you guys obviously gave us very good detail on your slides. And on the credit quality, slide 14, you give us the breakout in the net charge-offs, and you show us the reported number at 64 bps versus your core legacy number of 23 basis points. If I pull out the $189 million from the optimization, it looks like the net charge-off ratio is around 43 basis points, including the Union Bank numbers. Is that the level we should gear ourselves to for 2023 now that Union will be fully implemented into your business? Yeah. Let me clarify. So it's 64 basis points on a reported basis, 23 basis points on a core basis. And there's two components to that core; the balance sheet securitization that I talked about that you articulated. But then under CECL, what you end up having to do is you have to recapture loans that they have charged off you have to make an assessment. And then if you believe that, that charge-off was appropriate, you have to charge that off on day one, so to speak. And there was about $173 million of charge-offs related to those -- to that kind of day one effect associated with CECL. So there's really kind of three components. But 64% on a reported basis, 23% on a core basis. And when we think about going forward, I would use the 23 basis points as the start point, and that's about $210 million worth of core charge-offs. Hi and congratulations from my end too. And the deck is super clear. I really appreciate all the effort to make it simple and straightforward. So a couple of questions for me, just to follow-up on the discussion we just had. Could we also talk a little bit about how we should think about the reserving level as we go through 2023 and into 2024? Because like you said, you've got the fair value marks, you had to do the day, you had to do the add as per the CECL rules. So does reserve ratio stabilize from here? Does it actually inch down? Is there a scenario in which it would move higher? Could you just frame out how we should think about that? Thanks. Yeah. I mean, obviously, it is impacted by a lot of different things in terms of how economic uncertainty ends up changing and the mix of the portfolio, how it might change. But as we think about 2023, I think that, that 191 basis points is probably a good -- is a good metric throughout the year. It might inch down a little bit. But I think that, by and large, we feel pretty comfortable with that as we think about 2023 based upon our base case, so to speak. Okay. And then I have one other question on the growth of the balance sheet. I know you addressed this a bit before. But when I look at the 2023 guide versus 1Q 2023, it's a slower growth rate than I think we're used to seeing at USB. So maybe you could help us understand, is this a moderated growth rate during the integration phase and maybe second half that should accelerate up, or is this the level of growth that we should anticipate? And then if you don't mind, I have just a couple of ticky-tackies on the purchase accounting and the CDI and how we should expect that steps down into 2023 and 2024. Sure. Betsy, this is Andy. So first, on the growth rate, I think 2022 had exceptional loan growth across many categories, led by commercial as well as CRE. So what we would see is that more normalizing. You're starting to see that in the fourth quarter. And I think the other fact is that, the growth rates are impacted by average balances and some of the optimization activity that we took down in the fourth quarter. It was a partial quarter in the fourth quarter, full quarter in the first quarter and the rest of 2023. But the principal driver is a function of loan demand, which is moderating a bit across most categories. So it's still growing but a less than what we saw in 2022. And then, Betsy, maybe related to your second question, which was around the recognition of the core deposit intangible over time, probably the way that I would think about it is that, it's – it will amortize into income over about a 10-year period. It will step down, and probably a good way of just modeling it is assuming kind of a sum-of-the-years digit sort of approach. And same thing for PAA, or how should we think about that? I mean PAA, I know it's different, but PAA change… Yeah. So that's tied, obviously, to the life of the loans. And it will end up being impacted by prepayments and all sorts of things. If you end up looking at their portfolio that we acquired, about half of it is residential mortgage and half of it is corporate in shorter term. So probably, if you ended up looking at an average life of four, five years, four to six years, that sort of time frame, then of course, that will also accrete probably a little bit faster on the front end. Hi. Good morning. Congratulations. A couple of questions. The tangible book value recovery, the crossover and the fact that you'd recover that back quickly, can you just give any color on sort of what's the key driver of that? Is it just simply earnings, or is there something else underneath that also that's going to help that come back so quickly? Yeah. It's principally the accretion effect that we're going to see with respect to Union Bank, the marks and the underlying earnings of the company. Okay. So the – because I just heard you say, the accretion – the question that Betsy asked, purchase current accretion that half the loans are mortgages. So that will take – come down, I guess, over more slowly? So is that part of it that pre-purchase accounting accretion is going to stay high for longer? Yeah. No, I really think it's just – it really is the kind of the 8% to 9% accretion levels that we're expecting on – Okay. Got it. Okay. A couple of other little ones. Deposits, the decline that you had in the balance sheet optimization I think it's pretty sizable, $24 billion. Is it all UB, or is it some of yours? And which types of deposits? Yeah. It's a great question. From a deposit standpoint, when you think about kind of the optimization that we went through, we had kind of a focus on a couple of different things. We ended up looking at LCR ratios. We ended up looking at higher-cost deposits, whether that would be brokerage-type deposits or euro dollar deposits, those sorts of things. We made a very conscious decision after getting regulatory approval to kind of reposition that. On the Union Bank side, the one thing that I would point out is that, there's about $8 billion to $9 billion worth of deposits that came over that were more transitionary. And over time, those will transition back to their global investment bank as those customers, kind of, migrate. So, about half of that migrated in the fourth quarter, and I would expect probably the other half of that to migrate in early 2023. But those are kind of the things we ended up looking at with respect to deposit and deposit flows. So, it was really looking at trading out low-cost deposits -- or high-cost deposits for low-cost deposits that are coming over for Union Bank and then some of the Union Bank effect. And what was the OCI number at the end of the year? So, as we think about where -- the going to Category II, how quickly do you expect that to come down so that you can be in better shape? Yes. So, OCI at the end of the year is about $8 billion, and the duration of the portfolio is a little over 5%. So, if you can kind of take a look at that, obviously, that's assuming that rates don't move from here. Our positioning from an investment portfolio perspective is about 52%, 53% HTM. We've also entered into some pay fixed swaps that in effect kind of get that up to the high 50s. So, we feel like we're in a pretty good position to be able to deal with -- if rates move up a bit or if rates come down, we have some flexibility there as well. So, we feel like we're in a pretty good spot. Good morning. Can you talk about the pace of the capital build from the 8.4% to around 9% by the end of the year? And then also, if the macro is worse than expected and you have to build reserves more, I realize that doesn't move the capital that much. But obviously, everyone else is starting at a higher point of capital, and there is focus on how quickly you can get to that 9% or even higher. So, I guess the question is like what levers can you pull to kind of aren't that painful if you need a little bit more, such as issuing preferreds or some other assets that you could kind of exit without hitting earnings that much? Thank you. Yes, I mean, obviously, Matt, from a balance sheet optimization perspective, we're going to be very focused on profitability, returns. And capital is precious. So, we want to make sure that we are dedicating our resources from an asset growth perspective in the right spots. The pace of growth from 8.4% to a little above 9% by the end of 2023, it's fairly ratable across the four quarters. Obviously, first quarter is going to be a little bit lower simply because we will not have seen the cost synergies, and we will be going through and incurring more merger-related costs probably in the earlier part of the year simply because of the timing of the system conversion. So, the pace is probably a little bit more weighted towards the back end. But that hopefully, Matt, kind of gives you some perspective. Again, I'd kind of come back from a reserve point of view, we feel like we look at a lot of different scenarios. We look at the five different approaches, one of which is a severe recession. We take that into consideration. We could see unemployment move up to around 6%, 6.5%, and we still feel like we would be in a pretty good spot from a reserving point of view. So, if it ends up getting -- if it ends up being at a level that's higher, then we'll have to focus on other balance sheet optimization activity. Good morning guys. First question, I just wanted to ask is just to follow on the outlook for the year. Can you just walk us through just your underlying assumptions for how NII just projects, if we just think about the core business and in terms of what deposit costs and betas do and how that impacts the underlying trajectory from this first -- from the fourth quarter of NII? Yeah. So obviously, net interest income is going to be driven by the earning asset growth that we have in here as well as the margin expansion. We expect that margin expansion to take place five to 10 basis points in the first quarter because of the Union -- full quarter effect of Union Bank. And then again, our modeling is that the margin is -- reasonably moderates from there, reasonably flat, maybe up just a little bit. From a deposit point of view, clearly, deposit betas are going to accelerate. I think that's the reason why you'll see the moderation in terms of net interest income, or net interest margin expansion in the second half of the year. But keep in mind -- and again, this is kind of -- we see that in the first quarter. The Union Bank effect associated with the value of those deposits that we're bringing on, and we'll continue to look at opportunities to optimize the deposit portfolio. Okay. And then just one follow-up on the deal impact. Can you just remind us what type of like amortization period you're using for both the purchase accounting accretion and the CDI in terms of like, is this the run rate that we keep around for a few years, or does that change as you look past 2023? Thanks. Well, I think that, again, in 2023, we expect the purchase accounting accretion to be $350 million to $400 million and the CDI to be about $500 million. As I mentioned earlier, I think on the CDI, it steps down over time. But if you use a 10-year assumption and sum of year’s digits, I think that will get you from a modeling perspective pretty close to how I think it will end up amortizing off. The purchase accounting is really going to be tied to the asset lives because about half of it is mortgage and half of it is corporate and commercial, et cetera, and shorter-lived assets. I think you can think about that four to five-year sort of time frame, and it probably accretes down into a similar fashion, a little more front-end weighted. Good morning. Hi. Following up a bit on Mike and Ken's questions. If I look at your very helpful slide 18 on the guidance and I take the midpoint of $7.1 billion to $7.3 billion revenue range and I day weight that to the full year, I kind of get the lower range end of the full year guidance. 29.2 is actually what I get. So that implies like a couple percent growth in the back half of the year, which again, I guess, is better than what a lot of banks are saying. And I'm wondering, is that just underlying loan growth or fee income growth, or is it the tag-ins of the benefits of rising rates, or what do you see driving that? Well, again, I think you do see kind of the full year effect associated with rising interest rates kind of come into play. Fee revenue, on a legacy basis, as an example, we should see a little bit more of a tailwind next year as opposed to what we experienced this year. So I think that those are kind of coming into play. And then I think that just timing of being able to get cost synergies on the expense side. Yeah. And I'd add, it's probably just mathematically, as you were talking about it, you're right. And it's a little bit of a growth in the earning asset that you see there going up from 605 to 610 to 610 to 620. That's number one. And then maybe going towards the high end of that range and net interest margin versus the mid or low end in the early quarters. Yeah. Well, it's interesting because if I do the same analysis on the non-interest expense side, you're at the high end of that. So it implies kind of nice growth in pre-provision earnings through the course of the year. So – but anyway, that's it for me. AOCI, was it – I'm just going to remember here, $12 billion, now it's $8 billion? And where is it as of today? And then, Andy, just can you pull the lens back a little bit? It's been a rough 3, 5 and 10 years when you look at operating leverage in stock, not last year on the operating leverage. But that comment you made in December and you addressed briefly, but you've been in this investment cycle multi-years. And now you said that, you're coming out of it or the drag is less or maybe the spending is less and the payoffs are more. Can you just give us more color on both the spending side and the payback side and where you've invested the most and where you expect that payback? Because it sounds like you're crossing a line based on your comments from December and that you reiterated today? Thanks. Yes. Thanks, Mike. I think that's a fair representation. So we – our spend levels on pure CapEx were – grew from about $800 million to $900 million to $1.2 billion, $1.3 billion. And that growth has been in the run rate for the last couple of years. So you would not expect to see additional continued expense increase related to CapEx. Importantly, we also migrated that spend from about 60% defensive to 60% offensive. So the spend is on activities like digital capabilities, reaching customers, products and services and so forth. So all of that is what's coming through to right now, so a level set on the expense side plus a return on the investments from a revenue side. That, coupled with overlaying all that on the Union Bank customer base, is why we're projecting the numbers that we're giving you. Good morning, guys. Hey. Just a couple of quick follow-ups. So Terry, where does the balance sheet repositioning and the merger leave you in terms of interest rate positioning? How would you describe it here, fairly neutral, a little bit asset-sensitive, where you're ending up now? Yeah. I would say that, legacy US Bank is fairly neutral. When we add Union Bank on, it probably adds about 50 basis points of asset sensitivity in a 50 up sort of shock environment. Okay. And then on the fee income, you said some more tailwinds this year, some helpers on legacy U.S. Bancorp. What are those on the fee income front? What are the helpers this year that you can grow fee income? Maybe just puts and takes on fees real quick. Yes. Well, if you just kind of look at the different components, I think the payments revenue continues to be reasonably strong. I think that the expectation is the market comes back a little bit in terms of investment income. But deposit service charges, we saw a drag in 2022 because of some pricing changes we implemented in May. That starts to dissipate. So, I think it will be kind of a combination of things. But probably one of the biggest ones is just mortgage banking revenue. That has been a pretty significant drag, especially on a year-over-year basis. And in the fourth quarter, we actually started see that inflection point with linked-quarter revenue starting to come up, and we would expect that to be a little bit stronger as we go into 2023. Okay, got it. And then the last clarification. I think on reserves, you said the 1.9% ratio looks pretty good for this year. And even if unemployment went to 6%, 6.5%, you'd be okay? Yes. Again, we go through a lot of different scenarios and we take that downside into consideration and as part of kind of that weighted average process. We think 6%, 6.5% unemployment is already incorporated into our reserving process. So, -- but again, it all is going to depend upon what ends up happening, how severe the economic recession is, if there is one at all. So, I think there's just a lot of moving parts.
EarningCall_1490
All right. Good morning, and thank you for attending J.P. Morgan’s 21st Annual CES Conference. My name is Harlan Sur, semiconductor and semiconductor capital equipment analyst for the firm. Very pleased to have the team from ON Semi here with us today President and Chief Executive Officer, Hassane El-Khoury; Thad Trent, Chief Financial Officer; and we’ve got Parag Agarwal, Investor Relations here in the audience. So, gentlemen, thank you for joining us this morning. Happy New Year. I'm going to kick it off with the first few questions, and I'll turn it over to the audience to see if they have any questions. The team's strong revenue, margin, free cash flow performance has been driven by a strong foundation of technology, product differentiation, focus on core auto and industrial markets, right? Your design win pipeline has been a great indicator of future growth. In 2021, your design win funnel grew 60%, new product revenues grew 28%. How much did the design win funnel grow last year? And what are the areas or product categories within your core auto and industrial that saw the largest gains? Yes. Look, obviously, we're in the quiet period, so I won't comment on last year's result. We'll talk about those when we do our earnings. But overall, we've been investing and focusing on automotive and industrial. So a lot of our design win funnel growth has been in those areas, obviously, to follow our investment thesis that we've been putting together. We don't see that changing moving forward. If you look at our Analyst Day and even our projections that we've had since Analyst Day, where we expect the auto and industrial to outgrow the market given our focus on it, but also the content gains that we're doing. Within these, obviously, there are trends within each of these markets that are holding up and driving the design win funnel and subsequently, the growth in these markets. In the automotive, you have electrification and ADAS. In Industrial, what we call the core industrial, factory automation, energy infrastructure, medical, those are what's driving a lot of that design funnel and also, obviously, subsequently the revenue projections that we've had. Demand trends began to decelerate for the team Q2 of last year, driven by consumer-focused markets like PC, smartphones, consumer electronics. With automotive and industrial, roughly two-thirds of your revenue exposure remaining quite strong, right? The team took proactive measures in Q2, lowering utilizations, maintaining lean inventories with distribution partners. Q3, you saw weakness compute consumer and consumer-focused areas of your industrial business, right, that was sort of the incremental part. I know you're not going to - you're in quiet period. You're not going to talk about the near-term. But looking at full year calendar ‘23, qualitatively, what areas do you anticipate continuing to grow in segments that will be weak? Yes. Look, our view - our long-term view have not - has not changed. We expect growth in automotive. We expect growth in core industrial. A lot of the things that are more tied to PMI or GTP are just like consumer and compute, we expect those to be dependent on the market. And for us, we've set ourselves up, starting in the second quarter of last year, to be able to weather through these. Now, I'll remind everybody, we have about $400 million to $450 million in those markets that we have been working on pricing or sales out to the market. So that would accelerate with a softer outlook in the market, which is actually good for us because that business is actually still dilutive to margin even in the pricing environment that we've been in for the last couple of years. So as we wind that down and exit that business, it will actually help us overall. So net-net, it's actually a positive thing of how we're looking at 2023 as a transformative year to set ourselves up for the '24 and beyond. Last earnings call, you talked about the continued tight supply dynamics in auto and industrial and with a large percentage of the core industrial and auto business covered by long-term supply agreements. In fact, the team noted between long-term supply agreements and NCNR orders, the team's capacity is sold out in auto and Industrial for 2023. Again, I'm not asking about the near-term, but more on the 2023 profile, is that still the case that demand still outstrips the team's ability to supply in core auto and industrial for 2023? And maybe sort of more longer-term, the LTAs are great in times of strong demand, tight capacity. As we potentially move into a period of weaker demand, give us the advantages of these LTAs. And maybe more longer-term, how the LTAs resulted in stronger long-term strategic partnerships with customers where they're actually sharing their roadmaps for the next few years, which is quite different relative to, let's say, three, four, five years ago, Yes. So look, for the first part of the question, when we talk about the outlook and then 2023, we've always said we're pretty much sold out between the LTSAs and the NCNR where we're sold out. And given our market exposure, you can say it's auto and industrial are in that same category. As far as the LTSAs, look, I'll start by saying LTSAs for us, our long-term supply agreements are legally binding agreement between us and the customer. And what is included in those agreements is both pricing and volume. People ask about -- ask a lot of questions about what are we doing on backlog? How does the backlog? We're not really at this point, we're not building to backlog. We're building to LTSAs because that's where the customer signed. And when I say by the customer signed, it's not -- not minimizing the title, but it's not a director of procurement that's going to sign. In Europe, it's a member of the board. In North America, it has to be an officer of the company. For ourselves, it's me, Thad or our Head of Sales that sign. So they are legally binding agreement, it's their liability for the customer because they're take or pay. Now that's like you said, that's all great when everybody makes the parts. Now what happens in moving forward? Okay, look, we're not here to "shove the inventory". If the customer has a concern on demand where they say, okay, six months from now, it's not going to be where I thought it was going to be. That allows us a few things. One is we can manage our manufacturing. So you don't have WIP that's going to end up in inventory. If we do, the customer will have to take it because we're not going to be left holding the bag. It has to be a win-win. If I can move that capacity elsewhere because we're oversubscribed, that's even better for us and the customer. It's a win-win, again. What we're not going to have a conversation about is pricing, because that's usually where everything falls apart in a softer environment. People say, oh, well, I can find it 10% cheaper somewhere else. That's not negotiable. That's where we will execute the extent of the agreement. So that's the, call it, the framework of the LTSA and then our view and how we're approaching it. We haven't had to do that because we're not there yet. And we don't expect to have that -- those a lot of these conversations with our auto and industrial because of the other part of your question, which is the supply and demand. We're not able to support the demand that our customers want in 2023. So we're still supplying below demand. So even if demand fluctuate based on concerns and macro and all of that and demand fluctuates a little bit even with downward pressure, they'll just get closer to a supply that's still below it. So we're not concerned about what the macro demand environment is going to do to our business with the LTSAs. But the LTSAs do provide a very solid visibility on both of those. On the strategic aspect, though, I'll give you, call it, backward- looking data that gives you a projection of the front. A few quarters ago, we talked about increasing our LTSAs. Last quarter, Thad talked about, we incrementally added $5 billion to now total $14 billion of LTSA. This is overall in the company. That dynamic is new customer, but also existing customers that had an LTSA on maybe three or four parts that were highly constrained in 2021, we signed an LTSA. In '22, customers came back and said, that's great. It actually fit what we want. We didn't have to -- we were sleeping good at night for On Semi parts that are on the LTSA. I have 200 parts that I'd worry about. I want to put all of them in. Some of those LTSAs are eight years in length. So the next question is, well, how does the customer know what part? Well, they know what technology, and we will create the part together. That's the strategic importance of these where the customer knows, especially when they co-invest with us on a specific technology, and we say, okay, this analogue node, the customer is going to co-invest for capacity, it's to their benefit to create a roadmap on that technology with us. So it makes us, one, sticky and way more visibility long-term of what our demand and where the market is going. So net-net, it went from supply assurance to a very strategic document that both us and the customer are engaging with. Why? Because we delivered in the last two years to the essence of the LTSAs where we didn't take the customer lines now when they haven't LTSA. So they saw the value, they saw the value for us as a supplier, but they also saw the value of the breadth of technology that we are providing for their core in the automotive, for example, for their core vehicles, and that matters to the customer. Yes. And just let me add. Hassane talked about the duration of these. I think the perception sometimes is the short-term duration. These are not just for '23. Normally, they're three to four years plus. We're not doing something short-term to solve the short-term. And that's what makes it very strategic. And if we look at the softness that we saw in consumer and compute, the LTSA -- LTSAs held up in that process as well. So that's kind of our proof point that says we can enforce these with win-win situations with our customers. And does the LTSAs and periods of weakness actually motivate your customers to give you more heads up? Not -- three, four years ago, you guys would get 30 days notice, right? Yes, I'm not going to need these products. I'm cancelling my orders. And so does the LTA program actually motivate your customers to say, look, we're looking at the macro environment six months out, like things are looking squishy. Let's let the ON team know about this. Yes. That's exactly no, I joke with my team, like if the LTSA do one thing, it's somebody is going to pick up the bat phone and call me. I remember, in end of 2018 when kind of the backlog like got a 30% haircut, right, if you recall, I didn't even get a phone call. I just woke up in the morning. I thought it was a computer glitch where a backlog kind of somebody didn't add it up. Well, I don't want that. We were not going to be left holding the bag because, look, we made a lot of investments in order to support that outlook from our customers and therefore, it's a win-win. And the way they see it, they have to take the part, so it's a take or pay. But if they let us know six, nine months in advance that, hey, we -- this new model is not working out. Look, that's fine. The conversation is great. We'll take share on another model that works as long as we utilize the capacity. And the fact that customers, some customers have co-invested with us, they're more likely to give a share because of their investment from others in a, call it, in an environment where they don't have the full volume materialize. So all of those are win-win for us. And what we won't contemplate is the pricing discussion, right? That part of the pricings in there. So we won't have that discussion of I can get it cheaper down the road, right? It the pricings locked. What we can do is create that win-win if we can move that capacity to another customer. Sure, we'll help that customer out, but it's not a pricing discussion and that's why, on our last call, I was very comfortable saying the '23 pricing environment is extremely stable to us. But it's because we have that locked up on LTSA. Before I move on to some of the product and technology, does anybody have any questions? So let's move to your automotive segment. Back at Analyst Day, the team highlighted 17% full year revenue CAGR, right? That's your target CAGR of 21% to 25%. Given the strong 2022 performance, you guys are going to be up like 40% year- over year in auto, still implies low double-digit CAGR to meet that 17% target. Electrification is a big driver. xEV production is set to grow 30% CAGR over the next three years. And then on top of that, your dollar content in xEV can be as high incremental, as much as $700 per car. And then on top of that, ADAS is driving strong content growth for your image sensor and LiDAR products. It seems to us that the 17% growth target is going to prove to be somewhat conservative. Has the design win funnel in auto outperformed your expectations versus two years ago when you set the targets? Look, I think overall, the market has accelerated since we set the targets. Look, our investments match, the outlook - the new outlook that we have in the market, what I will tell you is we still expect to outgrow the general automotive market because we are exposed to the mega trends that are driving a lot of that growth, net of the things in auto that in the ICE engine and so on that we don’t play a lot in. So we're very comfortable in our outlook. We're very comfortable about maintaining our momentum, fuelled by a lot of the design wins, number one, and really the LTSAs that we've been talking about. Your silicon carbide power technology and portfolio has been a big driver of the design win pipeline and future revenue growth in your core markets. As with any new emerging technology, there can be a lot of noise out there, right? Noise around yields, reliability, scrappage, parametrics, and I can go on and on, right? But to me, the best way to ask the question that encompasses manufacturability, design, cost, share traction is, is the team tracking doing what they said they were going to do, right? Did the team grow its silicon carbide revenues by 3x in 2022? Is the team still on track to drive $1 billion of silicon carbide revenues this year and exiting this year with silicon carbide gross margins at sort of that corporate average gross margin level? Yes. So I'll focus on the outlook more importantly. So is the team from I know the fud out there in the yield and I don't react to it, nor do I spend time on that, because what I measure our team on, including from GTAT to wafer processing, EPI all the way because we are vertically integrated And we have metrics and deliverables in our annual plan last year and moving forward through every step of the way. So is the team delivering? The answer is yes. Because you never hear me in any form, talk about we plan for perfection and therefore, we're not on track. This stuff is hard. We have ramped many factories before. Forget about slicon carbide. When you ramp at scale, especially at the scale we are ramping and how fast we're ramping, there are ramp challenges. So we plan on those, and we have a team of experts that have that are currently running 20 factories for ON Semi worldwide. So they know how to ramp. They know how to tackle problems. They know how to tackle all these. So that makes me very comfortable because- and I give you one day. We've had issues during the ramp. Let's be realistic and we've tackled every single one of them before it becomes systemic. That is the difference between scale manufacturing and a startup. So we're not in that mode yet. So a lot of the conversations and so on, I know where it stems from. I'm not worried about it because we are a professional scale manufacturing company also, along with the technology innovator. So both of those puts us in a good position. So moving forward, we're still on track to deliver to our plans that we've talked about, the '23 plants. We talked about the start-up costs for silicon carbide being 100 basis points to 200 basis points, as we grow out of those tours exiting '23. If I take -- if I remove that stuff, I will tell you the silicon carbide margin is at or above our corporate margin. So as we grow into that capacity that we had to build ahead of time, you can expect that to be an actual tailwind. So all of these together are going to be helping our margin, but we're -- I would say we are on track to the plans we've set for ourselves, whether it's the plan from the acquisition of GTAT or the plans for the expansion of our Buchon fab, all these plans are being executed to our own plan. One of the things I feel like the market underappreciates is that the team has been in the power semiconductor market for over 30 years, right? And the market does tend to focus on silicon carbide. But ON Semi is a leader in IGBT, ON Semi is a leader in MOSFETs, right? And these two power technologies have been growing. I think, even recently, right, 30% year-over-year. And so these are driving very, very strong growth dynamics. So how much of the competitive advantage that you have on silicon carbide; process, manufacturing module development, understanding your customers' requirements, how much of this is attributed to your strong position in IGBT and MOSFET? I would say 100%. If you think about a lot of the conversations we've had and I've had externally, where I talked about one of our differentiation in module development. We have multiple decades of power semiconductor module development, design and manufacturing. That becomes even more important in silicon carbide, wide band gap. We've got a lot more power smaller area than silicon if you're not able to get that heat out in a very innovative package, you're not going to get the benefit that silicon carbide bring. You're just going to be paying a premium for the same performance if you think about it. So being able to do that, now people can say, well, yes, we can get the heat out, yes if you put a big hunk of metal, which adds weight and cost at the system level. So yes, you solved it. At a component level, you just buried the cost at a system level Our approach and our innovative approach for module development, we're able to do the best silicon carbide device in the best package designed for that device, lower material costs, lower manufacturing costs, better bond, all of these things that actually added up together is a much better efficiency at the system level that translates into either longer range or lower battery volume. Those are dollar numbers when it comes to the customer So that carried over -- that experience that carried over from silicon into silicon carbide is 100% applicable. And when people talk about how -- where did ON Semi come from where we were three, four years ago to now; $4 billion of LTSA is proving with our customers that we have the technology and the knowhow to deliver what they need for them to be successful. That's the win. Now from a manufacturing perspective, back to why I'm not worried about the ramp as much as a lot of the headlines on the fab out there is we're moving our IGBT. We have a fab in Korea in South Korea, it's a large scale power fab, six and eight inch that is doing IGBTs for a very long time. It just pumps, IGBTs, great yield, clean fab, excellent operational performance. What we've done is we moved the IGBTs to East Fishkill. So we moved it to 12-inch. And we're moving silicon carbide in an existing high-scale power fab. So I don't have the fab ramp challenges. We're increasing capacity, of course, but the fab runs power already. Whether it's silicon or silicon carbide, it's a power fab. So all of these put together put us in a very competitive position, one to tackle the market with our technology and two, to scale to support those customers One of the other benefits of the 1GBT and MOSFET leadership, right and if I look at that $4 billion pipeline in silicon carbide power products, these engagements, are creating I feel, additional dollar content attach opportunities for your MOSFET and IGBT portfolio, right, gate driver modules, DC to DC converters, IGBT inverter attach for front-wheel drive, just a few examples, right? You probably track this, but what's ON Semi's additional power, power management content attached to that $4 billion of silicon carbide revenue indiscernible? Well if you think about it, obviously, it's not a one-to-one, but you can think about, you got the $4 billion that we've talked about, and that's the three-year LTSA window for silicon carbide but a $15 billion or $14 billion overall. So you can think about a lot of these are with the same customers where the example I gave before, where you may have two or three parts and now the customer says, we've had a year now of seeing what is our supply chain for ON Semi, we want to add all of them. So that cross-selling is what we're looking at. Now as we look at road maps with customers, and we look at it from the system level design of what is the customer trying to accomplish, because back to having that breadth of technology, especially silicon carbide and IGBT, look at the customer and says, here's the problem we're trying to solve. If we're able to solve it with silicon power we're going to offer silicon power, I don't have to kind of corner into I only have silicon carbide. You have to have it. We're going to give the best solution for that customer and that matters from a competitive standpoint of being able to provide that the flexibility for both and that goes back to the comment you made where sometimes, it's a split axel. Front axles IGBT, we were actually set. What we're able to provide too, they don't have to go to another supplier. That is important for the customer. So all of these and the breadth of portfolio is a competitive advantage that we see because the customer can develop a system-level approach with one supplier where trade-offs are being made on the board with one logo, if you think about it. And that gives us the ability forward looking to see, okay, if we had to make these trade-offs, how can we design the next generation to not have these trade-offs? So you already design yourself into the next one because now you're codeveloping with the customer. Got it on silicon carbide substrate side, what's the mix of in-sourced versus outsourced supply of substrates today? And where will you be exiting this year and trajectory over the next three years as you sort of grow into the $4 billion revenue pipeline? Yes. Look, obviously, today well, it's known majority is external. As we ramp our GTAT, we've said we will be majority internal exiting '23. And that will continue to increase as we move forward. Our intent is to be supporting our customer ramps with internal substrate because that's the one we can depend on. When we talk about supply assurance, that's the one we can really commit to our customers. And obviously, we're going to have a little bit on externally. It's not going to be 100%, because you need to have the possibility to be able to spring up for certain, like a quarter of a big ramp, we want to be able to spring up. We can either do it by building ahead or by sourcing from the outside. So we'll do that. And that's why we have a good pulse on what we call the merchant market, what's out there. But our goal and our strategy, which has proven the right one already, is to have it internal. Let's move over to industrial. It's a large part of your business, obviously, very diversified. Some of the subsegments are there's multiyear demand drivers, right, like energy, infrastructure, automation. Energy infrastructure, for example, I think last you guys reported was like driving 60% year-over-year growth. Provide us some color on the exposure to the different subsegments within industrial? And which of those subsegments are more resilient, let's say, in a weaker macro environment? And at a high level, the seams confidence on growing the business this year, should things get weaker from a macro perspective? Yes. Look, in general, you highlighted the trends that are driving the industrial, what we call the core industrial energy infrastructure. That's a multiyear -- multi almost a decade long because it's going to be lockstep with the electrification. As you get more electric vehicles, you're going to have a bigger infrastructure that have more energy. What does that mean? The renewable energy from solar wind, but more importantly, is the energy storage with the unfortunate events in -- with the conflict in Europe, that accelerated a lot of the energy storage adoption in Europe, but also in North America, given a lot of the climate disruptions that we've had with the grid. So all of these have driven a lot stronger demand on the energy -- renewable energy market for us. That is both silicon carbide but also a very big market for IGBTs today. So those are areas that we don't see that slowing down because it's part of a larger mega trend. When let's say, you have concems about macro in '23, nobody is going to be like, let's not put chargers and let's not do this until '24. Those are not dependent on that because they're long-term investments. And the longer you wait, the worse it gets. So those, we don't see anything. And we've talked about how the top 10 energy renewable energy, including storage, have 80% market share: We have LTSAs with eight of the top 10. So that gives you where our growth and how broad our growth is when it comes to that tackling the market. Factory automation growth is driven by a different. It's driven by coming out of a two-year of shortage in labor, social distancing, pandemic, where you had to either shut down factories or run with a skeleton crew for social distancing. Well, the way you solve that is automation. That's driving cameras and analog power for factory automation. That bet will remain because we don't see maybe the social distancing is getting less but the labor shortage is not. You see what I mean? So those investments remain. And the last one I would highlight that we're focusing on is, of course, the medical, where macro or not, you can't push out medical procedures or medical needs. Those will get always prioritized independent of the macro. So I would say those are the ones that where our growth is coming into, and that's where our investments are going. So the outlook is positive because of these megatrends underlying industrial. And my last question, because we're running out of time here, is on the gross margin front. You did mention that there are some potential tailwinds to the gross margins. Obviously, there's offsets in a weaker macro environment underutilization. You've talked about some of the impacts East Fishkill and the start-up of the GTAT and the manufacturing and silicon. But as you mentioned, the team has exited $277 million of noncore revenues and an average gross margin of 25%. You're planning to exit another $65 million, $70 million in the December quarter. And then as you mentioned, Hassane, $400 million, $450 million remaining in calendar '23, which I believe has a gross margin profile in the low 40% range. So given the market softness into the first half of this year, should we think that the impact of that roll off of that $400 million, $450 million being more biased in the first half, just given that noncore products are more commodity-like and probably more sensitive to the macro trends? And so or would you expect that roll off to be sort of more linear as we move through the year? So what we're seeing right now, we've always said this is margin dependent, and we actually thought we'd lose this business faster than we have, right? We think we're going to be out of that business by the end of '23, given the market dynamics. What we're seeing right now is it's fairly linear, but probably more back-end loaded to the second half, if you think about it, kind of what the visibility we have on it today. If the macro gets softer and we lose it faster, that's good for us because we can reallocate that capacity to something of higher value. So it's really market-driven. There's not a whole lot we can do We've already priced ourselves in a position where we think we'll exit it, and that was all by design. We're expecting just one thing on the margin. When you talk about the tailwind, when you look at longer term, just your reminder, we exited four fabs in 2022, and we talked about $160 million of COGS favorability as we fully exit the fabs. We handed the keys to another partner. But as we move these products out of those fabs into our remaining fab network, we're going to be getting that $160 million. That's all tailwind above and beyond of where we are today. Of course, that takes time to fully exit fabs, think about two to three years. But that's still a taiwind that's yet ahead of incremental to the margin that we're able to achieve in the shorter term from that window. Absolutely. Absolutely. Looking forward to monitoring the progress and execution the team this year. Hassane, thank you very much for joining us today. We really appreciate it.
EarningCall_1491
Thank you for standing by. This is the conference operator. Welcome to Aritzia's Third Quarter 2023 Earnings Call. As a reminder, all participants are in listen-only mode and the conference is being recorded. [Operator Instructions] Thank you, [indiscernible], and thanks for joining Aritzia's third quarter fiscal 2023 earnings call. On the call today, I'm joined by Jennifer Wong, our Chief Executive Officer; Todd Ingledew, our Chief Financial Officer; and Brian Hill, our Founder and Executive Chair. Following prepared remarks from Jennifer and Todd there will be an opportunity to ask questions. Please note that remarks on this call may include our expectations, future plans, and intentions that may constitute forward-looking information. Such forward-looking information is based on estimates and assumptions made by management regarding among other things general economic and geopolitical conditions, the competitive environment, and further COVID-19 resurgences. Actual results may differ materially from the conclusions, forecast, or projections expressed by the forward-looking information. We will refer you to our most recently filed quarterly and annual management's discussion and analysis and our annual information form that is available on SEDAR, which include a summary of the material assumptions, as well as risks and factors that could affect our future performance and our ability to deliver on the forward-looking information. Our earnings release, the related financial statements, and the MD&A are available on SEDAR www.sedar.com, as well as the Investor Relations section of our website. Thanks, Beth. Good afternoon everyone, and thank you for joining us today. I hope you all enjoyed the holidays and Happy New Year from all of us at Aritzia. 2022 marked another exceptional year for our company as we welcomed new clients, grew our team of world-class talent, expanded our premier portfolio of boutique, and delivered a plan for our next phase of growth. Our performance in the third quarter of fiscal 2023 showcases the ongoing sales momentum that we're seeing in our business as our much loved everyday luxury experience continues to resonate with both new and existing clients. Our record Q3 sales were higher than anticipated as all geographies and all channels outperformed our expectations. Net revenue of $625 million increased 38% from last year with comparable sales growth of 23%. This growth was fueled by our business in the U.S. where our outstanding pace continued growing by 58% from last year. In Canada, we grew total sales by an impressive 22% and saw strong double-digit comparable sales growth. Our phenomenal sales results continue to be driven by new client acquisition as more people discover and become loyal to the Aritzia brand. During our Black Fiveday Event, we delivered record-breaking results with retail sales hitting an all-time high on Black Friday. In e-commerce, on one of the very first days of the event, we had our highest day ever and then beat that record again on Black Friday itself. During sale period, e-commerce is becoming a larger and larger contributor to our growth. Throughout the Black Fiveday Event, our concierge team kept pace handling 150,000 client interactions. I'm incredibly proud of all our team's dedication and hard work and our highly engaged people across North America along with our best-in-class processes and infrastructure allowed us to deliver another exceptional [Black Fiveday] [ph]. In Q3, our retail business surpassed our expectations increasing 39% from last year. Our tremendous momentum in the quarter was fueled by outstanding comparable sales growth in our boutiques, as well as the progress we made on our real estate expansion strategy. We opened four newly expanded boutiques in the quarter, starting with a record breaking opening day at our Pollo Park location in Winnipeg, and then ending the quarter with another record breaking opening day at our Yorkdale flagship in Toronto. Our boutique expansions are performing exceptionally well with the additional square footage allowing us to deliver an enhanced experience for our clients resulting in better than expected payback periods. In e-commerce, revenue grew an impressive 36% on top of 47% last year. We continue to experience strong traffic growth and demand. We also saw a meaningful lift in conversion as we benefited from site enhancements and our improved inventory position, compared to last year. On November 29, we celebrated the tenth anniversary of our e-commerce business. We've come a long way in our journey to create a best-in-class shopping experience and we remain committed to improving and elevating our online platform as we make progress towards delivering e-commerce 2.0. In Q3, we enhanced product discovery by making it easier for clients to shop matching sets, understand size, length and color availability, and navigate the site with [less growing] [ph]. We also optimized the types of images we use across various parts of our website to better enable clients to find and evaluate products. For example, we change product listing page images for our sale items to off-model from on-model, which makes it easier for our clients to identify which items are on sale. In Q3, key programs and client favorite continued to drive strong demand, which was balanced across the assortment. Selling in our professional, fashion, and tailored assortments continued to increase even as we maintained our momentum in lifestyle apparel. We also saw a strong start to the outerwear season. And we are pleased with the balanced demand we're seeing across our product offering as our multi-brand business model continues to enable us to cater to our clients' needs across all aspects of their lives. Our beautiful product and boutique expansion strategy continue to propel our brand awareness and drive increased market share. The Aritzia brand is resonating incredibly well on social media with our clients who are doing the talking for us. And to our own social and influencer strategies, we are emphasizing what they're saying. Our views on TikTok have surpassed 2 billion and are growing at a rate of nearly 100 million every month. In Q3, we continued to expand our influencer program, most notably with our Super on You campaign for the fall winter Super Puff collection featuring meaningfully more paid collaborations than last year. The campaign integrated seamlessly across all our marketing channels from social to aritzia.com and helps drive further progress on our path to getting famous in the U.S. where total client growth was 48%. Turning to supply chain, we saw record order and sales volume both online and in our boutiques during our Black Fiveday Event. We topped our record for most e-commerce orders processed in a single day, while getting packages to our clients on-time and more quickly than last year. I'd like to give a big shout-out to our distribution team who enabled us to deliver exceptional results during the quarter, while also managing earlier than expected delivery of our spring product. We ended the quarter with inventory up 187% over last year. The supply chain environment was dynamic and uncertain at the time we began placing orders for fall and winter product over 12 months ago. Given what we knew at the time, we made the strategic decision to order future season buys earlier in order to build back our inventory base due to unprecedented sales growth, mitigate supply chain risk, and ensure our ability to fuel the robust demand for our product. On top of that, improved freight timeline resulted in inventory arriving even sooner than anticipated. We expect inventory growth to begin to moderate as we move through Q4 and to more closely align with sales trends by the end of Q2 of fiscal 2024. We expect markdowns in Q4 to be no greater than pre-pandemic levels. We are confident with the composition of our inventory, which is heavily concentrated in client favorite and has certainly enabled the strong sales growth we have delivered. We believe we are positioned to capitalize on the continued robust demand for our products and the start of our spring selling season. While the competition for labor remains challenging, our growing recognition and industry leading wages have allowed us to continue to attract world-class talent. We are experiencing higher wages and salaries in our distribution centers and boutique network and adding headcount in our support office. Our people are a key component of the existing infrastructure that is enabling us to deliver 38% revenue growth, as well as the future infrastructure that will allow us to capitalize on our growth strategy as we deliver everyday luxury to more and more clients across the world. Investing in talent is an investment in our future. Turning to our ESG strategy, we have submitted a letter of intent to the science-based target initiatives confirming our commitment to set targets to reduce greenhouse gas emissions within the next 24 months. We're excited to join the more than 4,000 global organizations who are part of this initiative and our community remains a key priority for Aritzia and this year marked our third annual warm coat donation where we gifted 4,000 winter coats valued at over a million dollars to our Aritzia community partners across North America. This quarter, I did visit many of our boutiques both in Canada and across the South Eastern and Midwestern United States. What particularly impressed me is how well our everyday luxury experience has translated across geographies from Vancouver to Dallas and Toronto to Miami, the Aritzia brand is showing up wonderfully and consistently with a geographically diverse client base discovering and loving our beautiful products, aspirational shopping environment, and the exceptional service they're receiving from our very passionate [indiscernible]. I could not be more confident in our ongoing geographic expansion strategy and our runway for growth in the United States. Thanks, Jennifer, and good afternoon, everyone. We're extremely pleased with the ongoing momentum in our business as our everyday luxury experience continues to resonate with both new and existing clients across all geographies and channels. While our Black Fiveday Event broke a number of records, we are particularly pleased that the revenue growth rate during our 11 plus weeks of full price selling exceeded that of our sale period in the third quarter. For the third quarter, we generated net revenue of $625 million, an increase of 38% from last year, and achieved comparable sales growth of 22.8%. We delivered these outstanding results against the normalized third quarter last year. This is the first time in almost three years all of our boutiques were open for the entire quarter in both the current and comparable quarter. In the United States, we continue to see exceptional growth with net revenue of $314 million, an increase of 58% from last year. Our business in the United States accounted for 50% of net revenue in the third quarter, compared to 44% last year and 33% two years ago. This sustained momentum reflects the significant acceleration in our U.S. client base. Net revenue in our retail channel was $423 million, an increase of 39%. This was led by growth in the United States where our comparable new and expanded boutiques all delivered exceptional results. In Canada, we also saw strong performance in all our boutiques with double-digit growth in the retail channel. In e-commerce, our business continued to grow sequentially with net revenue of $201 million, an increase of 36% on top of a robust 47% increase in the third quarter last year and 79% in the third quarter two years ago during the pandemic. E-commerce trends were strong across all regions with growth predominantly driven by higher traffic and supported by increased conversion rates. We delivered gross profit of $271 million, up 29% from last year. Gross profit margin was 43.3% declining 310 basis points from 46.4% last year. The decline was driven by inflationary pressures, additional warehousing costs related to inventory management, and the weakening of the Canadian dollar. The above pressures were partially offset by lower expedited freight costs and leverage on occupancy and depreciation costs. SG&A expenses were $164 million or 26.2% of net revenue, compared to 24.3% last year. The 190 basis point increase reflects additional investments in retail talent to ensure we continue to deliver exceptional client service and ongoing investments in people, marketing, and technology to fuel our accelerated momentum and our future growth. Overall, adjusted EBITDA in the third quarter was $120 million, an increase of 9% from last year. Adjusted EBITDA was 19.2% of net revenue, compared to 24.1% last year. Inventory at the end of the third quarter was $508 million, an increase of 187%, compared to $177 million at the end of the third quarter last year. As a reminder, we had extremely low inventory levels in the back half of last year, which negatively impacted sales. We made the strategic decision to order future season buys earlier in order to build back our inventory base, mitigate supply chain risk, and ensure our ability to fuel the robust demand for our product. Due to the improved lead times, product has been arriving even earlier than anticipated, accentuating the comparison to the prior year. To provide more context on timing, our reported inventory includes inventory on-hand and in-transit. When we include inventory on order still at the factory, our total committed inventory at the end of the third quarter was up 35.6% over last year, in-line with our sales growth. To be clear, last year at the end of the third quarter, the vast majority of our committed inventory was still at the factory, due to the global supply chain challenges, where this year, the vast majority is either on-hand or in-transit. Overall, our inventory has enabled our outstanding sales growth and we are confident with the composition of our inventory, which is heavily concentrated in client favorites. In the fourth quarter, we expect normalized markdowns to be no greater than pre-pandemic levels, and looking forward, we expect the year-over-year inventory growth to begin to moderate at the end of the fourth quarter, and to normalize on a reported basis by the end of the second quarter of fiscal 2024. Since the implementation of our current NCIB on January 17, 2022, we have repurchased 1.8 million subordinate voting shares, returning $69.2 million to shareholders. Our liquidity position remains strong at the end of the third quarter with $132 million in cash and $0 drawn on our $175 million revolving credit facility. Turning to our outlook, the positive momentum in our business has continued into the fourth quarter. As such, we now expect net revenue for the fourth quarter to be in the range of $580 million to $600 million, representing an increase of approximately 31% to 35%, compared to last year. This reflects continued outperformance in the United States and in our e-commerce channel, as well as ongoing strength in Canada. For the full-year, we now expect net revenue to be in the range of $2.14 billion to $2.16 billion, up from our previous outlook of $2.00 billion to $2.05 billion. The new outlook now represents growth for the year of approximately 44% from fiscal 2022 on top of a 74% increase last year. In addition to the six new boutiques and four expanded boutiques opened year to date through the end of the third quarter, we have opened an additional two new boutiques in the United States in the fourth quarter to date and plan to reposition one additional boutique in Canada later this quarter. Turning to our gross profit margin. In the fourth quarter, we expect a decline of approximately 250 basis points, compared to the fourth quarter last year. Improvements from a reduction in the use of expedited freight will be offset by ongoing inflationary pressure, additional warehousing costs related to inventory management, and foreign currency headwinds, complying that we expect gross profit margin for the full-year to be approximately 200 basis points to 225 basis points below fiscal 2022. While we expect inflation to persist, in the coming year, some of these headwinds may subside. In addition, we will review opportunistic pricing to contribute to margin improvements. We expect SG&A as a percent of net revenue in the fourth quarter to be approximately flat with the fourth quarter last year. Leverage on fixed costs are being offset by ongoing investments in our infrastructure, to fuel our momentum and enable our future growth. While we continue to navigate an extraordinary operating environment, and accelerate our investments, over the long-term as our mix shift towards the United States and e-commerce, our leverage is expected to expand, driving the adjusted EBITDA margin target of approximately 19% by fiscal 2027 that we set forth in our long-term growth plan. In summary, we are extremely pleased with the strength of our business, particularly with our growth in the United States and the momentum in our e-commerce channel. Our balance sheet is strong and we will continue investing in our strategic initiatives and infrastructure, which will allow us to deliver on our long-term growth targets. We remain confident in our ability to drive sustained profitable growth well into the future, while delivering meaningful shareholder value. Thanks, Todd. And as Todd mentioned, the top line momentum from Q3 has continued through the back half of the holiday season and the start of our fall winter sale. And we're pleased with the success we're seeing across all product categories. Our markdown percentage remains no greater than pre-pandemic levels in-spite of a more normalized environment due to the improved inventory availability. In December, we opened two new boutiques in the U.S. La Cantera in San Antonio, which is a new market for us and already competing for our best boutique in Texas, and fashion outlets of Chicago. Next month, we'll open our newly expanded Upper Canada boutique in Toronto, which will feature an A-OK cafe. We remain extremely pleased with the results we're seeing in our expanded boutique, as well as in our new boutiques and new markets. And as we head into 2023, we remain laser focused on the development of beautiful, high quality products, as well as our engaging service, aspirational shopping environment, and captivating communication. We strive to delight our clients in each of these respects. And we believe our everyday luxury experience will continue to set us apart, propelling our brand and fueling our sales growth. And at the same time, we're intensely focused on driving growth that is both sustainable and profitable over the long-term. We remain focused on the core fundamentals that have made us successful for 40 years executing well across our growth pillars and investing in the infrastructure that will allow us to deliver on our long-term growth plan that we laid out for you last October. In closing, I would like to thank our entire team for their tremendous commitment and hard work and our clients for their enduring loyalty to Aritzia. Thank you. Good evening. Just wanted to follow-up on the inventory. Just a couple of questions. The first one is, could you just remind us what percentage of the inventory is composed of client favorites? And then the second one is, you talked about inventory arriving sooner than expected, which I think is driving just the incremental gross margin decline from what your previous guidance was. And does that mean that you have more non-seasonal inventory, like did you get stuff sooner in the calendar than you would have previously? Hi, Steve. First off, on the composition, the vast majority of the inventory is in our client favorites as we said to our proven sellers. And the inventory has arrived exceedingly early, as I stated. Last year, at this time, the vast majority of inventory was still at the factories and that was actually the backdrop with which we were making the buys for this season. And so, now that is completely flipped and the vast majority of our committed inventory is actually here on-hand or in-transit anyways. And so yes, our distribution centers are being pressured and we are seeing additional costs related to handling all of the inventory, but we're more than pleased with the composition of that inventory. It peaked in Q3. As we said, markdowns are expected to be no greater than our pre-pandemic levels. And we expect the inventory on a reported basis to begin to moderate as we move through Q4 and to more closely align with sales trends as I said by the end of Q2. Okay. That's good color, Todd. Thank you. Just along the lines of talking about the DC as sort of being pressured and that's causing – that's driving additional costs. Are those costs that you expect – obviously expect to continue to Q4, but would you expect as the inventory normalizes to a normalized level in Q1 and by the end of Q2? Will you still see those costs dragging in Q1 and Q2 of next year? Yes, that's our expectation at this point. We'll put a finer point on that next quarter when we report our outlook for next year. Hi. Just following up on that question a little bit. I guess the inventory impacts that you mentioned that you're starting to use lower expedited freight, can you quantify what you have in the past, what that, I guess positive impact was this quarter from the reduced use of expedited freight and what you think that could be in Q4? Yes. Well, in Q4, we provided the number last year. We had 400 basis points of pressure in Q4. We expect that we will have meaningfully less use of airfreight in this quarter in Q4. And the benefit in Q3 was approximately half of that 400 basis points, so roughly 200 basis points of benefit in Q3. Yes, no, understood. That's helpful. And then just in terms of the overall consumer spending environment, you know obviously, we’re seeing a lot of inflation and talks around a potential challenging environment heading into 2023, have you seen any change in the composition of your, for example, your e-commerce consumers versus brick and mortar or any changes in that exposure just given some of these consumer spending dynamics? We get asked that question a lot and we're watching it closely, but so far, what we're seeing is, a tremendous amount of consistency between who's shopping with us, what they're buying, their average basket size have not changed, the average selling price has not changed, the number of units has not changed. So, we're looking at all of these indicators and so far for us as consumer demand is not letting us and we're not seeing any notable changes in the behavior. Yes. And if I can just add to that, I think one of the things that is on display in our results is the fact that our retail revenue grew by 39% and our e-com side of the business grew by [36%] [ph]. So, very consistent growth across both channels. And then also, as I mentioned in my prepared remarks, we actually saw higher growth during Q3 in our full priced portion of the quarter, compared to our sale period in the quarter. So, I think that's another clear indicator of the strength of our client demand. Hi, good afternoon. Maybe to follow-up on that topic, it may be an obvious question, but I'd like to hear you develop on it. Why is it that you're not seeing any changes in your consumer patterns or given the inflation, given the rising interest rates? I'd love to hear a little bit as to why you think your customer base is less impacted or your sales were not impacted? I'm going to answer that first and feel free to jump in, Todd. I think it first and foremost starts with our unique positioning in the marketplace of everyday luxury. And there's really no one that does what we do or comes close to what we do. We offer a superior quality product that's beautiful that fits well, has a quality of construction, and a detail of design that is second to none and our clients recognize that. And it's priced at a price point that is for everyone. You add-on to that, our multi-brand strategy and our broad assortment. You know, I was saying a minute ago to the group, we have [indiscernible] and it's high quality wool coats and it's high quality stock. We have T-shirts to Super Puff. We have everything in between. And so, the broad assortment, multi-brand that cater to a specific segment of our market has a very, very broad appeal. And I think at the end of the day, the product stands for itself. Our shopping environment resonate well with our clients both physical and digital. We have a phenomenal group of style advisors in our boutiques that are so enthusiastic in providing exceptional customer experience and that extends to our concierge. You know, you can go through all areas of our business. When someone receiving their online order. They're delighted to unpack their order that has been carefully packed by our folks in the DC. And I think it's not any one thing, it’s all of these things that we have honed over the last [40 years] [ph] that makes Aritzia who we are in its everyday luxury. Okay, that's helpful. And my other question is on pricing. Todd, you mentioned that you expect inflationary pressure to persist and potentially looking at the price increases next year or in calendar 2023. Can you just discuss a little bit what you're thinking in terms of a number of percentages of SKUs, pricing, timing, just what are you factoring into your analysis right now? Martin, we knew you would ask this question. So, we've been asked about pricing in the past, we did, Todd did mention we're reviewing our pricing opportunistically. I think would answer that question in terms of our overall pricing strategy. We're always looking at our pricing and we have kept our prices stable up until now. And what we are doing is, we're taking – we're continuing to take a close look and looking at opportunities where we can look at our pricing. And if you start first with our new items, we always – I don't and it is not a price change or price increase. We launched with new items, priced appropriately based on cost structure, but also on what we believe the customer will bear. And so, we're pricing opportunistically and appropriately is when you look at our client favorite that our existing items, we are also looking at those and there will be select core items that we will opportunistically price as well. And then I would like to add the third point, which is as more of our business shift to the U.S. there is an effective increase in pricing just by nature of our business shifting to the U.S. So, in total, there's no actual timing. We don't know – we’ll advise you on timing upon our review, and I want to emphasize it will be select items and opportunistic. We do not have a target of numbers of styles or SKUs in mind. We are always very balanced in how we approach these types of things because this is – this would be a meaningful change in how we're approaching things if we do. Yes, thanks. Good afternoon. I wanted to follow-up on gross margin and Todd thanks for the detail and the quantification on the air freight costs, but hoping that you can quantify some of the other forces at play today like the normalization and the timing of sales and more being in sort of Jan, Feb, and lower margin periods, as well as the storage costs? And even if you don't sort of specifically quantify, just give us a sense of how much each of those forces weigh on the margin in Q4 and sort of drive that change in the outlook for the Q4 margin? Sure. So, as we stated, we're expecting gross profit to decline 250 basis points. In the fourth quarter that compares to 310 in the third quarter. We're going to see the pressures that we saw in the third quarter persist. So, those are inflation on product costs, wage rates at the DC shipping costs, etcetera. So, all of those costs were previously expected. However, the change is from the higher warehousing costs due to the early receipt of our spring inventory as I said. So, that's really the primary driver of the change. And if I looked at the pressure, we don't typically quantify the – each pressure, but inflationary is the majority. And then the others would be secondary to that. So, the existing inflationary pressure, but again, we are confident in the composition of our inventory and we're not making any changes to our promotional strategy and we continue to expect our markdowns, as I said, to be no greater than pre-pandemic levels. And frankly we're already into our selling season right now and that's what we're seeing. Yes. Understood. Okay. I appreciate all of that. Thank you. I wanted to ask about the, sort of labor market. And Jen, you highlighted some of the challenges there. Would just be helpful to hear a little bit more about that. Are the conditions tougher today than they were, say three months ago? And is that showing up just in higher labor costs or also, sort of increased vacancies or fewer scheduled hours than you might otherwise plan? Like do you think this is affecting the consumer experience at all? Well, we're always – you know, we've always driven in every single year for top talent, world-class talent. So, we're always very competitive with our wages and our salaries across the board. This year is a little different because as you all know, the macro environment of lower unemployment rates and the great resignation and [quiet quitting] [ph] it is generally tougher. That said, we've always been very good at attracting top talent and we've always been very good at being ahead of the curve in terms of our offering, it's like total rewards, remuneration wise for our people. And so, operationally, I don't think it translates anything in terms of the customer experience, but what it does mean and I try to emphasize this in my prepared remarks is that it's everything we do from creating beautiful product to creating exceptional client experience to start with people, starts and ends with people, and our current results of delivering a 38% sales increase this quarter is because of our people, and investing in the future in our long range plan and being successful in all of our growth levers, it is because of our people and investing in those people that we get in today and retaining them. So, it's not just about attracting people, it's about retaining people. And offering them a rewarding career, which I think as an employer, we know and I'm supposed to [indiscernible] for a very long standing rewarding career that we can offer then. It's just a matter of making sure we stay on top of that and it is just more competitive, plain, and simple. Okay. Thanks for that. I appreciate the color. And then just last – maybe just a quick follow-up with regards to, sort of the commentary around Q4 to date, just curious if there's any observable difference between Canada and the U.S.? I mean, you're saying, sort of trends are consistent, does that hold in, sort of both regions and all channels or both channels as well? Hi. Thank you for taking our question. I wanted to follow-up on Mark's gross margin question. So, on your 4Q guidance, down 250 basis points, was any of it due to incremental kind of promotions or markdowns or noticing the customer, maybe gravitating towards the discounted product, despite you holding promotional offerings at a similar level to pre-COVID? And then out of the warehousing costs, FX, and cost inflation components, how are you thinking about these impacts into fiscal 2024? Hi, Alice. No, none of the pressure on our gross profit in the fourth quarter is coming from markdowns that were unexpected. Our promotional strategy as we said is completely unchanged. And in fact, and I said it already twice now, but sorry to repeat again, but in Q3, our clients actually gravitated to the full price selling period and what we're seeing right now is in fact a balance between that as well where we are seeing a full price selling, as well as our promotional selling going exceedingly well obviously to be driving the results that we're projecting. And so, no, there's no pressure from markdowns. And then on the other question, we do expect that those costs related to management at the distribution center to continue on until the inventory normalizes so through Q1 and Q2 of next year, obviously declining as we go through. Got it. That's very helpful. And then when you say inflationary pressures, those are – you're referring to wage costs, right, not raw material inputs? Because will those become a cost benefit sometime in second half? There are – so as of right now, we are seeing inflation pressure on our product costs, as well as wage rates and shipping costs as well. And by shipping, I'm referring to within North America, shipping to clients. There's a lot of fuel surcharges being added, but yes, we are seeing – continuing to see inflation impacts on our product costs and we expect that to continue into the first half of next year. And then again, we'll provide more detail around our outlook for next year on our next call. Yes, good afternoon. Todd, I want to – I'm hoping you might be able to elaborate a little bit on the degradation in the [SG&A] [ph] margin profile as well. I know you attributed to people marketing and technology, but can you maybe just break down the increase to 50 basis point increase on an annual basis to SG&A? Oh, sorry. Yes, yes. So, the impact to our annual outlook for SG&A really comes from Q3 within the fourth quarter, where our expectations are effectively flat. So, we were a little higher than we anticipated in Q3 and that's the primary driver. And it's primarily from investments in our retail talent, compared to the year before where we were understaffed, frankly, in retail. And so, we're spending more. There is also inflationary pressure, as far as wages go within retail, but for the most part, it's additional hiring and ensuring that we have the right level of staff to provide our everyday luxury experience in the stores. Maybe I – we will provide our outlook for next year on the next call, but I would expect that our level of expenditure will persist and especially as it relates to retail labor. Okay. And I just want to clarify this point. I'm sorry to come back to you again, but when you look at your annual change on your gross margin guide, the majority, if not all of that pertains to supply chain and the increase in the warehousing cost that you're [indiscernible] as a result, is that correct? Thank you. I just had a follow-up question. Lots of great color, so thank you. I'm not sure if you want to disclose it, but I was just curious if you could give a bit of, like intra-quarter color on where inventory levels are trending, considering you've seen strong traffic, good mix and full priced and selling through the quarter? Just curious if you can give any sort of more specific guidance or indication? As we've already said, we expect the inventory levels to moderate by the end of the quarter. Obviously, we've had meaningful sales quarter to date, which is helping us lower that number as we work towards the end of the quarter, but we're also receiving spring product still that is continuing to again come earlier and earlier. So, again, we expect it to moderate by the end of the quarter at this point. Thanks again everyone for joining us this afternoon. We're available after the call to answer your questions and have a great day.
EarningCall_1492
Hello, everyone, and welcome to today's conference, Banner Corporation Fourth Quarter 2022 Conference Call and Webcast. My name is Bruno, and I will be coordinating your call today. [Operator Instructions] Thank you, Bruno, and good morning, and Happy New Year, everyone. I would also like to welcome you to the fourth quarter and full year 2022 earnings call for Banner Corporation. As is customary, joining me on the call today is Peter Conner, our Chief Financial Officer; Jill Rice, our Chief Credit Officer; and Rich Arnold, our Head of Investor Relations. Our presentation today discusses Banner's business outlook and will include forward-looking statements. So, statements include descriptions of management's plans, objectives or goals for future operations, products or services, forecasts of financial or other performance measures and statements about Banner's general outlook for economic and other conditions. We also may make other forward-looking statements in the question-and-answer period following management's discussion. These forward-looking statements are subject to a number of risks and uncertainties, and actual results may differ materially from those discussed today. Information on the risk factors that could cause actual results to differ are available from the earnings press release that was released yesterday and a recently filed Form 10-Q for the quarter ended September 30, 2022. Forward-looking statements are effective only as of the date they are made, and Banner assumes no obligation to update information concerning its expectations. Mark? Today, we will cover four primary items with you. First, I will provide you high-level comments on Banner's fourth quarter and full year 2022 performance; second, the actions Banner continues to take to support all of our stakeholders, including our Banner team, our clients, our communities and our shareholders; third, Jill Rice will provide comments on the current status of our loan portfolio; and finally, Peter Conner will provide more detail on our operating performance for the quarter, as well as provide an update on our strategic initiative called Banner Forward. As a reminder, the focus of Banner Forward is to accelerate growth in commercial banking, deepen relationships with retail clients, advance technology strategies and streamline our back office. Before I get started, I want to again thank all of my 2,000 colleagues in our company that continue implementing our Banner Forward initiatives and who are working extremely hard to assist our clients and communities. Banner has lived our core values, summed up as doing the right thing, for the past 132 years. Our overarching goal continues to be, do the right thing for our clients, our communities, our colleagues, our company and our shareholders, and to provide a consistent and reliable source of commerce and capital through all economic cycles and change events. I am pleased to report again to you that is exactly what we continue to do. I'm very proud of the entire Banner team that are living on our core values. Now, let me turn to an overview of our performance. As announced, Banner Corporation reported a net profit available to common shareholders of $54.4 million or $1.58 per diluted share for the quarter ended December 31, 2022. This compares to a net profit to common shareholders of $1.44 per share for the fourth quarter of 2021 and $1.43 per share for the third quarter of 2022. For the full year ended December 31, 2022, Banner Corporation reported a net income available to common shareholders of $195.4 million compared to $201 million for the full year 2021. The earnings comparison is impacted by: the provision or recapture of credit losses; excess liquidity, coupled with a rapid change in interest rates; our strategy to maintain a moderate risk profile; a gain on sale of four branches; and the acceleration of deferred loan fee income associated with the SBA loan forgiveness of Paycheck Protection loans. Peter will discuss these items in more detail shortly. To illustrate the core earnings power of Banner, I would direct your attention to pre-tax pre-provision earnings and excluding the impact of merger and acquisition expenses, COVID expenses, gains and losses on the sale of securities, Banner Forward expenses, changes in fair value of financial instruments and the gain on the sale of branches, full year 2022 earnings were $251.9 million compared to $223.1 million for the full year of 2021. Banner's fourth quarter 2022 revenue from core operations increased 9% to $175.7 million compared to $161.5 million for the third quarter of 2022, and $143.4 million in the fourth quarter a year ago. For the full year 2022, revenue from core operations increased 6% to $623.1 million when compared to the full year 2021. We continue to benefit from strong core deposit base and improving net interest margin and good core expense control. Overall, this resulted in a return-on-average assets of 1.34% for the fourth quarter of 2022. Once again, our core performance reflects continued execution on our super community bank strategy; that is, growing new client relationships, adding to our core funding position by growing core deposits and promoting client loyalty and advocacy through our responsive service model. To that point, our core deposits represent 95% of total deposits. Further, we continued our strong organic generation of new relationships, and our loans outside of PPP loans increased 13% over the same period last year. Reflective of the solid performance, coupled with our strong regulatory capital ratios, we announced a core dividend of $0.48 per common share, up 9% from our last dividend. As noted in the release, Banner published our inaugural Environmental, Social and Governance Highlights Report in December. This report addresses many of the ways in which we are striving to do the right thing to support our clients, our communities and our colleagues. And while it covers many of the items I have mentioned before, including providing SBA payroll protection funds, totaling more than $1.6 billion for approximately 13,000 clients, as well as the $1.5 million commitment to support minority-owned businesses in our footprint, a $1 million equity investment in City First Bank, the largest Black-lead depository financial institution in the United States. It goes much further in outlining the level of commitment Banner has to the many communities in which we serve. If you haven't yet, I encourage you to take a few moments to review it. Finally, I'm pleased to say that we continue to receive marketplace recognition and validation of our business model and our value proposition. J.D. Power and Associates ranked Banner the Number One bank in the Northwest for client satisfaction for the sixth time. Banner has been named one of America's 100 Best Banks by Forbes, and Banner Bank received an outstanding CRA rating in our most recent CRA examination. Let me now turn the call over to Jill to discuss trends in our loan portfolio, and her comments on Banner's credit quality. Jill? As was detailed within our fourth quarter press release, Banner's credit metrics remain strong. Delinquent loans as of December 31 remained low at 0.32% of total loans, up 10 basis points when compared to the prior quarter and compared to 0.21% as of December 31, 2021. Adversely classified loans represent 1.35% of total loans, down from 1.39% as of the linked quarter and compared to 2.18% as of December 31, 2021. Nonperforming assets remained modest at 0.15% of total assets, but as noted in the press release, increased $7.8 million in the quarter and now total $23.4 million. Nonperforming assets are comprised primarily of nonperforming loans totaling $23 million. Given another quarter of strong loan growth and coupled with the continued negative economic sentiment, we posted a $6 million provision for loan losses and provided an additional $680,000 to the reserve for unfunded commitments. Net loan losses continued to be modest, and for the full year, Banner reported a net recovery of $1.2 million due to the strong collection work within our Special Assets department. After the provision, our ACL reserve totals $141.5 million or 1.39% of total loans as of December 31, an increase of 1 basis point from the linked quarter and compares to a reserve of 1.45% as of December 31, 2021. The reserve currently provides 615% coverage of our nonperforming loans. Looking at the loan portfolio. Origination volumes continue to be robust in the fourth quarter, with portfolio loan growth of $320 million in the quarter or 13% on an annualized basis. Excluding the growth in the one- to four-family portfolio, the annualized growth rate remained strong at 8%. C&I activity remained strong in the fourth quarter. For the full year, we reported commercial loan growth of $238 million plus an additional $155 million in the small business scored loans, which on a combined basis, equates to growth of 21% in the commercial lending arena. This growth is in spite of nearly $270 million in payoffs over the course of the past 12 months. The new loan originations continue to be modest in size, much of it to existing clients and is diversified both by industry and geographic location. C&I utilization is flat when compared to last quarter, however, it has increased 3% year-over-year. Commercial real estate balances declined $152 million or 4% year-over-year, a function of the significant CRE payoffs experienced this past year. Over the past four quarters, commercial real estate payoffs totaled nearly $500 million due to rate and term refinances, property sales and adversely classified relationship exits. As reported in prior quarters, the growth in the multifamily portfolio represents both new term loans as well as the conversion of completed multifamily construction projects, up 26% year-over-year. With the transfer of multifamily held-for-sale loans to the portfolio this quarter, the multifamily portfolio is now approximately 50% affordable housing and 50% market rate, and as noted before, remains granular in exposure and geographically diversified. Construction and development loan balances grew by 3% in the quarter due to draws on commercial and multifamily construction projects. As anticipated, the volume of one- to four-family residential construction projects has slowed significantly, which is reflected in the reduction in outstanding balances quarter-over-quarter. In total, construction and land development loans reflect an increase of 14% year-over-year, driven primarily by the multifamily construction portfolio. While the volume of residential construction starts has slowed, I am pleased to report that the portfolio continues to perform well and is diversified both in product mix and across our geography. Additionally, our underwriting standards have remained consistent and our land exposure is limited to our strongest sponsors. We expect that we will begin to carry completed homes longer as we move through this next year and anticipate seeing more builder concessions as clients work to keep their finished product moving. Still, our builders remain well capitalized and prepared to absorb the anticipated slower sales activity. Our total residential construction exposure remains acceptable at 6% of the portfolio. And consistent with prior reporting periods, nearly 40% of that is our custom one- to four-family residential mortgage loan products. When you include multifamily commercial construction and land, the total construction exposure remains at 15% of total loans, consistent with last quarter. And as noted in the earnings release, we again reported solid growth in the consumer mortgage portfolio. Again, a function of moving completed all-in-one custom construction loans on balance sheet. We reported a modest increase quarter-over-quarter in HELOC balances, up 4%, with solid growth of 24% year-over-year due to a very successful home equity campaign recorded in prior quarters. Lastly, the growth in other consumer loans year-over-year was the result of a small consumer pleasure boat portfolio located within footprint that was completed in the third quarter. I will wrap up my comments as I have the last few quarters noting that the continued overhang of pessimism as it relates to the economic environment we are facing. Still, Banner's credit culture is designed for success through all business cycles. Our consistent underwriting remains a source of strength, as does our solid reserve for loan losses and robust capital base. Banner's credit metrics remain strong and our moderate risk profile remains intact, positioning us well to navigate whatever the next phase of this economic cycle brings. And as discussed previously and as announced in our earnings release, we reported net income of $54 million or $1.58 per diluted share for the fourth quarter compared to $49 million or $1.43 per diluted share for the third quarter. The $0.15 increase in earnings per share was due to an increase in net interest income, partially offset by lower noninterest income, higher noninterest expense, and a larger provision for loan losses this quarter. Core revenue, excluding gains and losses on securities, changes in fair value of financial instruments carried at fair value and gains on the sale of sold branches increased $14.2 million from the prior quarter due to an increase in net interest income and noninterest income. Noninterest expenses, excluding Banner Forward, increased $3.6 million, due primarily to an accrual for a specific litigation matter, increases in occupancy expense and lower capitalized loan origination costs. Turning to the balance sheet. Total loans increased $292 million from the prior quarter-end as a result of increases in held-for-portfolio loans, partially offset by a $27 million decline in held-for-sale loans. Excluding PPP loans and held-for-sale loans, portfolio loans increased $325 million or 13.1% on an annualized basis. One- to four-family real estate loans grew $148 million in the current quarter as a result of directing potential custom construction mortgage loans on the portfolio. We anticipate a slower pace of on-balance sheet mortgage production in the coming quarters. Ending-core deposits decreased $616 million from the prior quarter-end due to outflows of rate-sensitive balances. The long-term decline in time deposit balances pivoted and increased $2 million from the prior quarter-end for the first time in this rate cycle, as existing clients transferred funds from their core deposit accounts to higher-yielding CDs. We anticipate further declines in core deposit balances, partially offset with growth in time deposits in coming quarters, albeit at a slower pace than we experienced in the fourth quarter, commensurate with the anticipated slowdown in the pace of Fed fund hikes. The loan-to-deposit ratio at the end of the quarter remained at a moderate at 74.5%. Net interest income increased $12.6 million from the prior quarter due to an expansion of the net interest margin, coupled with growth in average loan outstandings and lower balances of lower-yielding overnight interest-bearing cash. Compared to the prior quarter, loan yields increased 32 basis points, excluding the impact of PPP loan forgiveness, prepayment penalties, interest recoveries and acquired loan accretion. The average loan coupon increased 37 basis points from the prior quarter due to increases in floating and adjustable-rate loans and higher yields on new fixed rate term loans. The average interest-bearing cash and investment balances declined $571 million from the prior quarter, while the average yield on the combined cash and interest balances increased 41 basis points due to higher yields on both the securities portfolio and overnight funds, driven by higher market rates. Total cost of funds increased 5 basis points to 18 basis points due to increases in deposit rates and borrowing costs. The total cost of deposits increased 3 basis points to 10 basis points, reflecting modest increases in money market rates and CDs. The ratio of core deposits to total deposits remained steady at 95%, the same as last quarter. The net interest margin increased 38 basis points to 4.23% on a tax equivalent basis. The increase was driven by higher yield on loans, securities and overnight cash, coupled with a larger mix of loans and a lower mix of overnight cash within the earning asset base. In the coming quarters, we anticipate a slowdown in the pace of margin expansion as rate-sensitive deposits move off the balance sheet, the pace of loan yield increase slows, overnight interest-bearing cash levels decline and deposit rates increase. Going forward, we anticipate loan growth and deposit outflows will be funded primarily with security sales and secondarily with borrowings. Total noninterest income declined $2.5 million from the prior quarter. The current quarter was impacted by a $3.7 million loss on the sale of securities. Core noninterest income, excluding the gains on sales of the securities, gain on the sale of branches and changes in investments carried at fair value, increased $1.6 million. Total deposit fees decreased $628,000 while mortgage banking income increased $2.2 million due to an increase in the fair value of multifamily loans held for sale, partially offset by a decline in residential mortgage gain on sale income. Total residential mortgage production, including both loans held for investment and those held for sale, declined 49% from the prior quarter, reflecting the continued headwinds of higher rates and a slowdown in home sales. Within residential mortgage production, the percentage of refinance volume continued to decline as a function of rising rates, dropping to 10% of total production, down from 12% in the prior quarter. Multifamily loan production remained even with the prior quarter and the fair value of the held-for-sale portfolio improved as a function of higher yields on recently originated loans and a decline in market rates. Miscellaneous fee income decreased due to gains on nonperforming loans taken in the prior quarter. Total noninterest expense increased $4 million from the prior quarter, due to an accrual for an anticipated settlement of a previously disclosed litigation matter, lower deduction for capitalized loan origination costs and an increase in Banner Forward-related occupancy exit costs. Excluding the litigation settlement accrual and Banner Forward, noninterest expense was flat to the prior quarter. Capitalized loan origination costs decreased due to lower construction one- to four-residential mortgage and HELOC loan production compared to the prior quarter. Compensation expense declined by $1.3 million, due to declines in mortgage loan commission and medical claims expense. Occupancy expense -- occupancy and equipment costs increased $1.5 million due to Banner Forward-related facility exit costs and weather-related building maintenance expense. Professional and legal expense increased $3.7 million due to the aforementioned anticipated settlement of an outstanding litigation matter. Majority of the Banner Forward program initiatives were in place as of the current quarter. We anticipate the remaining run rate in Banner Forward-related performance improvements to occur over the course of 2023 as additional administrative building space is consolidated along with anticipated increases in selected deposit product service charges and continued acquisition of small business and middle market relationships. In closing, the company continues to benefit from rising rates, along with the improved operating leverage put in place by Banner Forward as evidenced by the significant improvement in the company's core ROA and efficiency ratio. Thank you, Peter and Jill, for your comments. That concludes our prepared remarks. And Bruno, we will now open the call and welcome your questions. Perfect. Thank you, Mark. [Operator Instructions] Our first question is from Jeff Rulis from D.A. Davidson. Jeff, please go ahead. Your line is now open. Just a question on the non-accruals, it looks like the increases in the C&I and 1 to 4 family, could you offer any color as to -- is it timing or anything that you're seeing there? And just thoughts on overall, Jill, I appreciate the kind of the statistics of delinquency and other, but specifically those credits that were added and then just a general sense type of commentary. Yes, good morning, Jeff. So as to the change in the non-performing, you hit the categories, there isn't any one specific driver on the 1 to 4 family. Some of it is timing. December is month where people tend to put their cash into things other than their mortgage at times. But beyond that, we had a small modest SBA guaranteed loan put on non-accrual, while we work through the credit resolution process and then various small business loans, nothing that is tending to point to any one issue or any one industry or things like that at this point, Jeff? Okay. And maybe, Peter, on the expenses, I guess, core expenses in the, call it, the mid-90s. You mentioned there can be some probably some Banner Forward exit costs potentially if there's more consolidation. But just kind of getting a sense for kind of growth rate off of maybe that 95-ish base for '23. And if you can touch on your expectation on additional Banner Forward expenses, that would be helpful. Sure, Jeff. Yes, the -- so in terms of our guidance for '23, we continue to guide in the low to mid-90s in terms of core expense. For 2023, we have some ins and outs going into '23. We'll have some reductions in occupancy expense as those facilities are consolidated over the course of '23. We don't anticipate any material restructuring or exit costs. There might be a few modest amounts there, but nothing material for '23. And then we do anticipate the compensation line item to continue to run, albeit for first quarter where we have some payroll tax increases to run at or perhaps even a little bit lower than what we had in the fourth quarter because of some elevated bonus, incentive accruals that we are running in Q4. So, my guidance is we'll see something basically similar to that low to mid-90s throughout the course of 2023 with somewhat higher first quarter compensation costs. But overall, we don't see a large increase in the run rate of the expense base going into '23. Perfect. Thank you, Jeff. Our next question is from David Feaster from Raymond James. David, your line is now open. Please go ahead. I just wanted -- I wanted to touch base on kind of your thoughts on credit in some regard, you tend to have a very conservative approach and good insights. But curious as maybe as you look at your portfolio and you stress some of the floating rate borrowers that have seen their borrowing costs increased materially over the past 12-months. Have you seen any material changes in debt service coverage ratios? And as you look at the prospects for another 50 basis points of hikes or whatever, how do cash flows and collateral values change? And as some of these loans come up for renewal, just how are you thinking about it? And ultimately, how do you think about the impacts on credit quality? Do we see more restructurings? Or just curious how you think about it. Thank you, David. That was a wide-ranging question there as to thinking about credit. But as we go into each of these loans, I need to remind you first that we stress them at origination for a rising rate environment and for changes in collateral value. So we start with the collateral coverage that is strong going in and is prepared to cover us in the event of changes in that collateral value. Debt service coverages for the variable rate loans certainly are being impacted as rates go up, but we do not have a -- our portfolio has strong guarantors behind it with generally secondary sources to supplant anything that might impact the business. So we're watching it. We stress the portfolio. But again, going in, we're looking at it as if we will enter a rising rate environment as if collateral values can change and recognizing that, that very low interest rate environment couldn't last forever, even though it lasted for several years. Okay. Okay. And then maybe just touching on the growth side. I mean you touched on some of the unique dynamics with mortgage and construction converting the perm and that potentially slowing or decelerating. If we look exclusive of that, loan growth was kind of in that 7% ballpark. I'm just curious how you think about loan growth going forward? You talked about slowing originations and some weaker demand in the market is kind of maybe a mid single-digit pace of growth realistic? Or I guess, even on the other side, what's your appetite for credit here, just given the market backdrop. So I'll start with the second half of that question first. Our appetite for credit, the answer to that thinks with the fact that we want to be open for business through all credit cycles. So we want to make loans certainly. We want to make good loans, and we anticipate doing so through the cycle. As to overall loan growth expectations, certainly, they've moderated given the continued economic pessimism, the increased and increasing rate environment and the overall general uncertainty as to market conditions. Pipeline volumes were down as of year-end, and they're rebuilding, but it's at a more measured pace. So with that, I anticipate continued increases in line utilization, the headwinds of the refinance activity have slowed, which will help in terms of loan growth. And with our super community bank model, I anticipate loan growth in the low single-digit range for 2023. Okay. Okay. That's helpful. And then maybe could you just touch on some of the competitive dynamics on the deposit front and some of the trends you're seeing? It sounds like we're expecting some continued outflows, but just -- could you talk about some of the drivers of the flows that you're seeing? How much of it maybe is more of the surge deposits outflowing or some seasonal dynamics versus clients utilizing cash to either -- rather than -- to either pay down debt or pursue projects and not take on higher cost debt? Or is it more price-sensitive clients migrating to try and get higher rates? Just curious some of the competitive dynamics you're seeing. And if you could talk about how you think about your willingness to defend deposits and keep those on balance sheet versus letting more outflows accelerate? Yes, David, it's Peter. Yes, so to kind of address the deposit outflow composition. So in the fourth quarter, when we looked at the -- if we were to dive into the composition of that outflow, two-thirds of that decline came from business accounts. And those clients were reducing excess operating cash and/or paying down loans with their excess cash in the fourth quarter. And then we also saw some of the more rate-sensitive components of our existing consumer client deposit accounts move to online high rate offerings. But we think a lot of this kind of initial decline was some of the surgery excess balance an the most rate-sensitive clients moving early first. As we get further into '23, we think the pace of that outflow will decline as we get to the bedrock of our core deposit base and some of the surge buoyances have already moved. As we said, our deposit base is very diversified both from a geographic market perspective, both in rural metro markets, but it's also very granular. We have a lot of deposit accounts with a relatively low average balance, compared to our peers. And so we think that is going to create integrity and stickiness to our core deposit base through this rate cycle. In terms of our tactics around pricing, we tend to price right in the median of our peer bank and community bank competition market-by-market, and we continue to do that. And then we couple that with selected CD specials to retain some more rate-sensitive balances with Banner. And then finally, we have a delegated exception pricing model that goes down to our branch network that allow on a selected basis, exception pricing of certain clients for retention purposes without having to reprice the entire portfolio. and those tools worked effectively in the last rate cycle back in '17 or '18. We think they were going to be effective again in this rate cycle. That being said, we anticipate low low single-digit pace of core deposit outflow here for the next couple of quarters. Nothing that was unanticipated, and we'll see some of our CD balances actually go up over the same period of time, but we have ample liquidity to support some modest outflow of the higher rate-sensitive balance as we get through the cycle, but we do anticipate a continued slowdown in the pace of outflow as we get further into the rate cycle. Perfect. Thank you, David. Our next question is from Andrew Liesch from Piper Sandler. Andrew, please go ahead. Your line is now open. Thanks. Hi, good morning, everyone. So just given where liquidity now sits and some of these balance sheet trends that you're noting, do you think the margin has now peaked? Hi, Andrew, it's Peter. There's some more to run here in terms of upside. It's just -- it will be at a slower pace, and we have some confidence there in the form of the pace of loan yield repricing and to a lesser extent, in the aggregate securities portfolio continue to move up with the pace of Fed funds hikes and the lag effect of the loan book repricing based on prior increases in Fed funds. And you can see the loan mix reflects that in terms of our adjustable and floating rate book, but also higher yields coming in on the fixed rate side, all overall active. We put a chart in the investor deck this quarter that illustrates not just the production, but the average yield on new production. And if you look at that chart in the fourth quarter, the average yield on new loan originations was about 6.4%. So loans are coming in accretive to our existing portfolio yield, and there's a carrier lag effect that will continue to have a positive effect on average loan yields quarter-to-quarter for the next several quarters. And at the same time, the pace of funding costs will continue to be less than the increase in earning asset yield. It's just going to continue to slow down. We're not going to see the big pace we had in the last couple of quarters, but we do anticipate some room to run here before it peaks out, but it's likely it will peak out in the -- towards the second half of '23, assuming the Fed does another 50 basis points of short-term hikes that would likely peak sometime in the second half of '23. Okay. That's really helpful. A little bit longer than I would have thought. And then just you also mentioned funding some of the deposit outflows or loan growth with security sales or borrowings. I guess, how do you balance that? Because I would imagine a lot of the securities would result -- sales would result in additional losses, but then the funding might be higher rate on the borrowing side. So how do you balance that decision? Yes. We've got -- our securities book is we've characterized it as a barbell in nature in the past with a component of short-duration security along with some more traditional long-duration MBS and CMO securities. There's an adequate amount of liquidity available in the securities portfolio at modest fair value losses that we have -- we're planning to use to fund both loan growth and deposit outflows without any inordinate realized losses as we sell it. So, securities will be the primary source of liquidity. Secondarily, we'll look to the FHLB, but that will be very much of a secondary need. We don't expect a lot of leverage or FHLB borrowings to support both additional deposit outflows or loan fundings here, and we expect very modest losses on any security sales that we need to generate to support that. Got you. And then can you just remind us what the monthly or quarterly cash flows off the securities book are? Yes. I think we've said in the past that the run rate amortization on the securities book [went] (ph) about $25 million a month. So, I think about $75 million to maybe $80 million a quarter and just natural amortization and prepayment activity on the securities book. Perfect. Thank you, Andrew. Our next question is from Andrew Terrell from Stephens. Andrew, your line is now open. Please go ahead. I wanted to go back to some of the discussion on just like the fixed and adjustable loans. I think both are 36% of total and just the repricing dynamics there and maybe some margin tailwinds longer term there. I was hoping, I guess, do you have a breakout of roughly per year, how much in fixed and adjustable rate loans either reprice or mature? . Yes, I don't have any exact number for you, Andrew. The duration on our fixed rate loan book is somewhere between 12 and 18 months on a weighted average basis. So you can kind of think about those loans repricing around that level of frequency. We have -- obviously, we're taking a bit more duration overall on the loan book and encouraging our bankers to do that. We've been doing that since the beginning of the rate cycle as to get more duration as we hit the top of the rate cycle. And so, we're seeing some of that effect in the extended duration in the loan book as we get further into the rate cycle by design. The addressable loans are typically FHLB or treasury index loans that reprice between three months and five years. So they have a -- there's a bit of an increase that's still to carry there as we price off of higher baseline indices that have yet to run through the repricing process. And so to remind you, we have floors, we have a floor mandate on all floating rate and adjusted weight loans, and I would characterize on the floating rate book, we have a higher percentage of floors on that subsection of loans that are LIBOR or SOFR overnight price loans, that's closer to 80% of those floating rate loans we have a floor on them, that's within a reasonable strike price of the actual loan yield. So we feel pretty good about the embedded optionality we've got in our loan book without having to go out and put a big portfolio floors in the book. we've got it naturally embedded in our loan portfolio as it is. So we'll have some nicer symmetry when rates come down in the future, given the floors that we've been putting in on the way up. Okay, I appreciate it. And maybe one for Jill on the construction portfolio. I think a lot of investors kind of focused on dynamics within construction books right now. I was hoping maybe you could just spend a little bit of time talking about, kind of, specific credit metrics that you underwrite to in this book of business? And then maybe any trends you're seeing within the permanent financing market? Yes, Andrew. So on the construction portfolio, I don't want to get too specific as to our credit underwriting metrics, but we do require cash equity in on those projects. We have a pretty strong book of builders in there. The market, as we've talked about, they continue to be undersupplied in terms of available homes, and so we're still seeing good movement in that product. As to the underwriting, the permanent mortgage loans, was that the first part -- second part of your question, Andrew? Yes. So the permanent loans, we're underwriting to the secondary market generally and then determining whether we want to keep it on balance sheet or not for loan growth. The custom all in one, we price that a little higher than the standard market rate so that theoretically, you would be able to float that down and sell it into the secondary market. The fact we would expect from the loans originated late '21 and into early '22, because of the rate environment at that time, those will still come on to balance sheet as the construction continues because of the low rate at that time. But the underwriting is generally set in that so that we will sell it in the secondary market upon completion. Thank you, Andrew. [Operator Instructions] Our next question is from Kelly Motta from KBW. Kelly, your line is now open. Please go ahead. Hi, good morning. Thanks for the questions. Congrats on a great quarter. Most of my questions have been asked and answered at this point. But just wondering, given the position you're in, in that you have a lot more liquidity so -- than some other banks that may be are having more issues. Just wondering if the pace or consistency of M&A discussions has picked up at all or any changes there in the last couple of months? Well, good morning, Kelly, this is Mark, and thank you for the question, and thank you for your compliment. We thought it was a very strong quarter as well. Look, I think the bank M&A environment right now is pretty stagnant just because of various things, not just interest rate sensitivity and a lot of institutions, but also the uncertainty with the credit environment or what you may potentially buy, be buying, along with accounting rules associated with an M&A transaction, so it's going to be fairly muted here. But our philosophy hasn't changed, our policies haven't changed. We continue to have a select group of companies that we admire and that we think would be great partners with Banner, and we continue to have that dialogue. And it's more important to have that dialogue now more than ever. as we get through this cycle as to where the opportunities might exist for combinations. If you think about our acquisition strategy and our combination strategy, it has always been opportunistic. And it has been -- transactions that have been nurtured over several years of understanding their company and their management team and our company and our management team. So I see that process continuing right now. Thanks for all the color, Mark appreciate it. My next one is for Jill, we're just taking a deeper look. I think office is getting -- have continued to get a lot of attention. Can you refresh us on your exposures there? And any sort of LTVs or debt service coverage ratios for that portfolio that you can share with us as well as kind of a nature of that book? Sure, Kelly. Like everyone, we continue to watch the office market closely, and our portfolio is performing well. Limited exposure in total, it's 7% of the loan book and really important to think that we -- remember, we don't have or have very limited exposure to anything in the core business districts. Our office portfolio is relatively small at -- or as I already said that 7% of the loan book, but 50% of it is owner-occupied. The granularity adds to limiting the exposure average individual loan size of the investor portion of that portfolio is roughly $2 million. When you add in the owner-occupied portfolio, it drops pretty significantly from that. We've maintained consistent underwriting. I would say that over the course of the last, say post pandemic, our office portfolio has had roughly a 60% loan-to-value going in and a north of 150 debt service coverage going in. Appreciate the color there Jill. That's really helpful. My last question for you all today is just -- I apologize if I missed it, but did you provide any guidance or outlook around fees for 2023? Yes, we didn't provide any guidance, but we think the fourth quarter is representative. It's a good baseline. It reflects the muted mortgage environment. We're seeing some green shoots in mortgage, given the drop in the 10-year, but our expectation is we're going to run at the lower levels we've seen in the last quarter or two in residential mortgage for the bulk of 2023. And we'll see some the deposit fees, while we have some selected deposit product fee changes coming in the second half of '23 as part of Banner Forward. We're seeing a little bit of offset with the ECR rate going up on our analysis fees as we hold those analysis deposits, we're giving more compensating credit in the ECR rates. So, our deposit fees are going to generally kind of trend neutral to what we've seen in the last quarter. So, all that being said, in multifamily, we think we'll have a better year than we did in '22. So, we should see some upside in multifamily given the marks that we took on it in '22. But overall, we think it will be very similar to '22 in terms of the aggregate core fee income trend in '23. Thank you, Kelly. Our next question is from Tim Coffey from Janney Montgomery & Scott. Tim, your line is open. Please go ahead. Great. Thanks, good morning, everybody and appreciate the opportunity to ask question here. Peter, as you look to sell securities this next year, do you have any -- have you ballparked what the cost of that would be or could be potentially, would it be anything like you saw in the fourth quarter? Yes. I think there's kind of a low single-digit loss on sale and liquidating secures that we need to sell the fund loan growth or deposit outflows. But we -- the securities portfolio is stratified with QSIPs that have no loss on them to those that have a more significant mark based on duration. And so, we're going to triage the securities portfolio in terms of sale based on balance, we're going to risk return and yield dilution decision. But there's -- just to remind you, right now, there's $300 million of overnight repos that come up for maturity here in the first and second quarter that have no mark on them and then we've got the remaining portfolio that have relatively low marks on it. So we have ample liquidity there without inordinate loss on sale to take advantage of to fund the company as we go through '23, so we don't think it will be a material number. Okay, Great. That's great color. And then, Mark, you've got probably one of the best -- the best footprint of any West Coast bank. And I'm wondering, as you look across your geography, are you seeing certain markets performing better than others? Yes. I think -- thanks, Tim, for the question. And look, I think -- we still see very strong economic drivers long-term in the Pacific Northwest. And Northern California is a very stable market, I would characterize. It's where you start to see in Southern California, some of the out migration occurring, some headwinds to the business community associated with some political issues and tax issues. But for the most part, I think as we go through the cycle, all of these geographies are going to benefit very, very well from an economic rebound. Most of the markets in the Northwest are still experiencing population in migration. They're still experiencing per capita income growth, and we expect that trend to continue over time. Even with some of the headline press of some of the technology layoffs or layoffs associated with aerospace, the markets we're in are generally not going to be as impacted as greatly as the headline news. So we're very optimistic about the markets, and we're very optimistic about the trends -- the long-term trends continuing very favorably for us. Okay. And then from -- just maybe a general comment of what you're seeing from your competition. Are there still irrational actors out there in the marketplace? Or are you starting to see people pulling back in a little bit? Yes, Tim, I'd like to term you've set me up well. People talk about irrational behavior coming from other institutions. I tend to look at it this way from our management team's perspective. We don't believe that other competitors act irrationally, we just simply don't understand the rationale of why they're doing what they're doing. So there are certain folks that I would characterize were much more aggressive in their behavior than then we would be previously. I think that has normalized now given some of the liquidity constraints of some of our competitors. And I think the marketplace is rationalizing because of the amount of uncertainty that's out there. So I think things have stabilized to a more fundamental underwriting and pricing behavior in the marketplace. That being said, when you flip -- that's on the credit and loan front, when you flip to the deposit side, remember, we have folks in our marketplace that -- such as credit unions and some financial institutions that need -- that are more than 100% loan-to-deposit ratios that are pricing deposit base are running certain CD campaigns that are significantly above ours. And we're simply not going to chase that or compete against that. So again, I don't know that that's a rational, but it's what they need to do as they see fit for their own business models. Hopefully, that's helpful. All right. Thank you, Tim. We currently have no further questions. I will now hand back to our speaker for final comments. Mark, please go ahead. Thank you, Bruno. As I stated, we are very proud of the Banner team and our fourth quarter and full-year 2022 performance. Thank you for your interest in Banner and joining us on the call today. We look forward to reporting our results to you again in the future. Have a wonderful day, everyone.
EarningCall_1493
Greetings. Welcome to the E2open Earnings Call for Fiscal Third Quarter 2023 Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note, this conference is being recorded. Good afternoon, everyone. At this time, I’d like to welcome you all to the E2open fiscal third quarter 2023 earnings conference call. I am Adam Rogers, Head of Investor Relations here at E2open. Today’s call will include recorded comments from our Chief Executive Officer, Michael Farlekas; followed by our Chief Financial Officer, Marje Armstrong. And then, we’ll open the call for a live Q&A session. A replay of this call will be available on our website. Information to access the replay is listed in today’s press release, which is available at e2open.com in the Investor Relations section. Before we begin, I’d like to remind everyone that during today’s call, we will be making forward-looking statements regarding future events and financial performance, including guidance for our fiscal fourth quarter and full fiscal year 2023. These forward-looking statements are subject to known and unknown risks and uncertainties. E2open cautions that these statements are not guarantees of future performance. We encourage you to review our most recent reports, including our 10-Q, or any applicable amendments for a complete discussion of these factors and other risks that may affect our future results or the market price of our stock. And finally, we are not obligating ourselves to revise our results or these forward-looking statements in light of new information or future events. Also during today’s call, we will refer to certain non-GAAP financial measures. Reconciliations of non-GAAP to GAAP measures and certain additional information are included in today’s earnings press release, which can be viewed and downloaded from our Investor Relations website. We had a strong third quarter against the continued backdrop of a challenging macro environment. We exceeded our guidance for subscription revenue, our primary focus, while expanding profitability and free cash flow. We look forward to sharing our results with you and providing an update about our business. During the call, I’ll discuss our third quarter highlights, how our clients are using our network and platform and an update on the FY '23 strategic investment areas we discussed previously. Marje will cover the third quarter financial results in more detail. And lastly, we will open up the call for Q&A. Let’s begin with the third quarter. We had a strong quarter. We exceeded our subscription revenue guidance, generating a record $135 million in subscription revenue, which represents 82% of our total revenue. We continue our track record of being highly profitable, delivering record adjusted EBITDA of over $56 million. This translates to a 34% EBITDA margin. The organic growth rate of subscription revenue, our primary focus, was over 10% for Q3 on a constant currency basis. In the nearly two years as a public company, we have consistently grown subscription and total revenue while maintaining very strong profitability. Our consistent subscription revenue growth in the double digits for the last six quarters is a result of our breadth of product offerings, the diversity of markets from an industry and geographic perspective and the value our innovations unlock for our clients who leverage our mission-critical applications. Stated more simply, we have multiple ways of winning. Let me provide you with some examples of what I mean by multiple ways to win, illustrated by how our clients are using the platform and our network. We recently signed an expansive contract with global retail leader, HUGO BOSS. The agreement covers a range of our solutions from supplier collaboration to logistics, providing end-to-end supply chain visibility and control. Specifically, HUGO BOSS will leverage our network and applications to optimize and manage internal and outsourced manufacturing. The solution enables collaborative capacity and forecast visibility, a robust secure to pay solution and agile transportation management capabilities. This project will give them full visibility and significant reduced cycle times, ensuring exceptional on-time delivery, which are the key performance indicators for any fashion company. It’s a significant new logo win and brought to us specifically because of the marketing investment we initiated earlier this year. Our network and product breadth were the primary factors in winning this large multiyear contract. On the other end of the industry spectrum, we also signed a contract that includes multiple solutions for a global agribusiness innovator. That contract, along with HUGO BOSS, helps demonstrate that our end-to-end supply chain platform works well across a wide range of industries. Like all quarters, Q3 brought many go-lives for new and existing clients, with a few I’d like to highlight. We recently went live with the first phase of Amazon Kuiper’s satellite project, which will enable high-speed Internet access to unserved and underserved parts of the world. We have been working with Kuiper for the past year to help them build their supply chain focused on manufacturing, collaboration and planning. Cloud network leader, Extreme Networks, went live with E2open's Partner Performance Incentives application, paying to their distributors over $66 million using our application within the first week of go-live. We don’t always discuss our channel business on these calls, but our solutions are value-add to the entire network, helping facilitate payments and rebates while offering greater pricing visibility. An international mining and metals company is using E2open for global trade management. They now have a single platform for global regulation, a centralized product classification repository, automatic export and import controls on all shipments and more with eyes towards future logistics capabilities. One of the world’s largest consumer goods companies went live on E2open and Maersk’s NeoNav platform, a collaborative next-generation solution that offers complete logistics visibility, control and decision-making through the integration of all trading partners and data in one closed-loop system. The system provides predictive visibility and traceability throughout the supply chain in real time. This project delivers on multiple strategic objectives for the Company, a single operational process, a control of inventory, both upstream and downstream, reduced costs through purchase order collaboration, and increase customer service levels. In addition to new logo wins and expanding client opportunities, network innovation is also a strategic priority for us. In November, we introduced E2open’s Carrier Marketplace as part of E2open’s broader strategy to expand the network ecosystem. The Carrier Marketplace offers carrier partners and shippers powerful new capabilities, including access to more data that allows both, carriers and shippers to make better proactive decisions. Over 8,000 carriers leverage this network today, and we believe our new marketplace will help unlock more value for the entire ecosystem. Now, I’d like to update you on our progress against the stated strategic investment areas we laid out at the beginning of the year: investing in sales and marketing; increasing brand awareness; and our work with strategic partners and our initiative to build systems integrator ecosystems. We’ve seen good progress in our sales and marketing and brand investments. As evidenced in top-of-funnel pipeline growth since initiating these investments, and as noted earlier, opportunities specifically generated by this investment that are now flowing through as new client wins. Our brand awareness metrics have dramatically improved as measured by share of voice where we are now consistently number 1 or number 2 in share of voice for our cohorts. Even though our investments in this area have been relatively modest, we’ve seen great success. On the strategic partnership front, this work continues with both, our strategic partners and building our integrator ecosystem. This is long-term work that does not happen overnight. That said, we are making solid progress in both areas and are hitting our internal marks. Both initiatives will have the effect of decoupling our services growth rate from our subscription growth rate, with our primary focus on growing subscription revenue. By enabling the SIs such as our partners, Accenture and KPMG to build their own practice and business on our platform, we’re unlocking the extraordinary influencing capacity these global partners bring to our business. This means that services will continue to decouple from subscriptions and be a shorter-term drag on overall growth by design to support long-term subscription revenue growth. Finally, I’d like to mention a few other corporate highlights. We continue to build on our ESG initiatives. E2open released its second annual environmental, social and governance report in the third quarter. Our software can have an enormous effect by reducing the environmental impact of our clients as they produce transport and distribute their products. And to this end, ESG is part of our road map development. As a company, E2open held an enterprise-wide employee giving campaign supporting Water For People. Water For People facilitates the development of clean water, improve sanitation and health and hygiene in 9 countries across Latin America, Africa and India. We ran this campaign through the end of 2022, and E2open provided matching donations to this amazing organization. Lastly, we were named the top enterprise SaaS solution of the year in 2022 Best in Biz Awards, along with others for most innovative SaaS solutions. E2open remains focused on our clients. We have multiple ways to win. And despite the macro environment, we continue to deliver consistent subscription revenue growth while being highly profitable. Our performance in Q3 and our outlook for the year are evidence of our focus on profitable growth and disciplined operations. This focus allows us to maintain our EBITDA and free cash flow targets even while our total revenue expectations for the year have come down due to FX, economic and business reasons that Marje will discuss in more detail. We delivered adjusted EBITDA margins of over 30% as reported for the last seven quarters. E2open is a reliable growth company that generates high margins and significant free cash flow. We are a mission-critical software company with durable revenue, consistent growth, long-tenured clients and are also highly profitable. We are laying the foundation to become the world’s preeminent supply chain software company. We have work to do, but then realize the opportunity as we are clear on the mission and our strategic path forward. Lastly, I’d like to thank our nearly 4,000 team members for their continued work and dedication to excellence for our clients, our communities and our company. Marje will now review our financial performance in greater detail. Marje? Thank you, Michael, and good afternoon, everyone. I hope everyone had a wonderful holiday season and a fantastic start to the new year. First, I wanted to thank the broader finance teams at E2open. Your efforts to get us ready for earnings working through the holidays are much appreciated. I’m incredibly proud of the stellar team around me, and I’m looking forward to all that we can accomplish together in 2023. As Michael mentioned, we had another strong quarter, and we’re excited to share those results with you today. I will begin by reviewing our fiscal third quarter results. I will then briefly touch on our progress integrating our recent acquisitions and then finish with an update to our guidance. Thereafter, Michael and I will open the call for your questions. As a quick note, I will talk about our results on a non-GAAP basis. We show a reconciliation to GAAP measures in the press release, which is available in the Investor Relations section of our website at e2open.com. In the fiscal third quarter of ‘23, we reported subscription revenue of $134.9 million, reflecting an organic revenue growth rate of 8.0% on a pro forma basis or 10.2% on a constant currency basis when adjusting for the negative $2.7 million year-over-year impact from foreign exchange fluctuations. This was above the high end of our guidance range of $131 million to $134 million. In the first nine months of fiscal ‘23, subscription organic revenue grew 11.0% on a pro forma constant currency basis. Delivering the consistent and predictable subscription revenue stream remains our core focus and is the foundation of our durable and highly profitable business. Professional services and other revenue were $30 million, reflecting an organic growth rate of negative 9.2% on a pro forma basis or negative 6.6% on a constant currency basis when adjusting for a negative $900,000 year-over-year impact from foreign exchange fluctuations. We have a stated strategy to focus on durable high-margin subscription revenue over services revenue. In addition, as Michael mentioned and we have also discussed on our previous earnings call, we are strategically shifting our services revenues to new partnerships with system integrators as part of the planned expansion of our channel ecosystem in order to aid our future subscription revenue growth. However, our services revenue is underperforming against our expectations, while our services gross margins improved from Q2. We are focused on addressing two main key areas to turn services revenues back to growth. First, we mentioned last quarter that Logistyx, a business we acquired earlier this fiscal year, has been a drag on the services revenues due to free service hours as we transition certain clients to our cloud platform. We continue to address this issue and expect the trend to improve as we move into fiscal 2024. Second, there are some pockets of unmet demand as we ramp trained employees and contractors to be fully billable. We’re working to adjust the supply and demand balance of our team to better anticipate client needs by product, so we can more closely match the demand we see with the supply we have. Aside from these two items, there are also macro impacts beyond our control as select customers, especially in the technology space, are temporarily slowing or pausing larger transportation projects. We expect those impacts to normalize and the projects to be picked up again as the macro environment stabilizes. We expect our services revenues to return to being additive to our top line growth profile as we work through the near-term issues over the next couple of quarters. We reported total revenue in the fiscal third quarter of $164.9 million, reflecting the total organic revenue year-over-year growth rate of 4.4% on a pro forma basis or 6.7% on a constant currency basis when adjusting for a negative $3.6 million year-over-year impact from foreign exchange fluctuations. In the first nine months of fiscal ‘23, total organic revenue grew 8.9% on a pro forma constant currency basis. Our gross profit was $113.6 million in the fiscal third quarter, reflecting a 4.9% increase on a pro forma basis or 6.1% increase on a constant currency basis. Gross margin was 68.9% for the third quarter of fiscal ‘23 compared to 68.6% in the comparable period in fiscal ‘22 or 68.2% on a constant currency basis. I will now walk you through the supplemental slides we prepared to help bridge the year-over-year impacts to our gross margin. These slides are also posted to the Investor Relations section of e2open.com. As you can see, the first bar on the slide represents FX, which had an approximate $1 million negative year-over-year impact to our gross margin. The second bar shows a strategic system integrator spend impact to gross margin, which was $2 million this quarter, but was not present in the year-ago period. As mentioned earlier, we’re building a global systems integrators ecosystem and have been investing in training staff and developing go-to-market capabilities with organizations such as KPMG and Accenture. This is part of the previously disclosed $20 million investment spend for fiscal year ‘23. Net organic margin growth was a $7 million positive impact to our gross margin, primarily driven by higher subscription revenue. Adjusted EBITDA was $56.2 million compared to $46.0 million in the prior third quarter, an increase of 22.1%. Adjusted EBITDA margin was 34.1% or 32.6% on a constant currency basis for the third quarter of fiscal ‘23 as compared to EBITDA margin of 29.1% during Q3 of fiscal ‘22 on a pro forma basis. The next slide details the items impacting our third quarter fiscal ‘23 EBITDA when compared to the year-ago period. FX was an approximately $1 million year-over-year benefit to our EBITDA line. As discussed during our previous earnings call, we have natural cost hedges to our largest top line currency exposures, which are the euro and the pound, along with additional costs in other currencies. The second bar on this slide, investment spend, refers to the previously disclosed $20 million fiscal year ‘23 investment in system integrator ecosystem, marketing and internal support for investment spend, which totaled $6 million in the third quarter. Similar to our second quarter, approximately $2 million of the $6 million investment spend relates to the system integrators, and therefore, sits within our gross margin line. The balance of $4 million is part of OpEx and only impacts EBITDA. Net organic margin growth was $9 million positive impact to our adjusted EBITDA, primarily driven by gross margin improvement, coupled with various OpEx cost saving initiatives. Net income for the third quarter of fiscal 2023 was $5.5 million and adjusted earnings per share was $0.06 on approximately 341.4 million adjusted basic shares outstanding. Now on to cash flow. I want to spend some time on this topic as generating compounding free cash flow growth is a core focus for us. As a supplement to the GAAP cash flow view, we have been providing an adjusted unlevered free cash flow view that starts with adjusted EBITDA and subtracts normalized CapEx, that is CapEx, excluding onetime M&A spend. Adjusted unlevered free cash flow for that definition was $50.4 million for the third quarter and $132.4 million for the first nine months of fiscal 2023. Going forward, in order to provide a clearer view of our normalized cash flow, we will start with GAAP operating cash flow that already takes into account cash interest, net working capital and cash taxes as opposed to the previous view that started with adjusted EBITDA. We adjust the GAAP view for nonrecurring onetime and M&A cash payments to derive an adjusted operating cash flow. Our adjusted operating cash flow for Q3 was $50.7 million, and for the first nine months of fiscal ‘23 was $75.0 million. We will continue to provide the disclosures on normalized CapEx expenditures similar to what we have done in historical periods to derive adjusted free cash flow. Our adjusted free cash flow for Q3 was $44.9 million and for the first nine months of fiscal 2023 was $51.4 million. This format should provide more clarity on operating cash flow generation adjusting for nonrecurring items, particularly given our historically acquisitive nature. We have included the year-to-date view in the supplemental slides this quarter, and we will be presenting it in our quarterly press release going forward. We will be retiring the old adjusted unlevered free cash flow view, but it can still be easily derived by taking our EBITDA minus the normalized CapEx figure that will still be provided in the adjusted cash flow walk. Timing differences of cash inflows and outflows can have a significant impact on quarterly cash flows as a normal course of business, which is why it is important to look at cash flow on a rolling basis, normalizing out quarterly fluctuations. As an example for our Q3 cash flow, I would point out two items. First, it includes the catch-up on delayed billings from Q2 BluJay ERP migration that depressed collections in that period. Second, Q3 cash interest payments were below normal run rate due to a timing shift of cash payments into Q4. As a result, we will see Q4 cash interest payments approximately $12 million above normal run rate. To reiterate, building a business that generates compounding cash flow is a core focus for us. And finding additional efficiencies and levers for cash flow growth generation will continue to be a priority for us. Now to provide a brief update on our recent acquisitions. We are complete with our integration of BluJay Solutions that closed on September 1, 2021. As mentioned last quarter, we surpassed our original synergy target of $25 million. Now turning to the Logistyx acquisition. Total synergies related to the recent Logistyx combination are still projected to be just over $10 million. We expect to action approximately 75% of run rate savings and realize 50% to 60% of the run rate savings by the end of fiscal 2023. As previously discussed, the Logistyx systems integrations are taking slightly longer than expected. However, we remain excited about the long-term additive value of this acquisition and are confident in our ability to achieve the previously announced synergies. Now on to guidance. Our GAAP subscription revenue for fiscal ‘23 is now expected to be in the range of $533 million to $536 million, which includes an approximate $2 million positive FX impact compared to the last time we reported earnings as the euro and the British pound have incrementally strengthened against the dollar. We now expect an approximate $9 million negative headwind year-over-year from FX. Our subscription revenue organic constant currency year-over-year growth is expected to be in the range of 9.9% to 10.5%. We are adjusting the lower end of our GAAP subscription revenue guidance on a constant currency basis, down by $3 million, and tightening the range to $3 million, representing the guidance range of $542 million to $545 million. As mentioned last quarter, we have seen delays in select large deal closings due to a volatile macro environment. While some of the deals delayed from Q2 did close in Q3, some are still delayed, and we’re seeing a similar trend carrying through Q3 and Q4. We do expect those projects to be picked up again as the macro environment stabilizes in the coming quarters as the demand for our mission-critical platform remains as strong as ever. Total GAAP revenue for fiscal ‘23 is now expected to be in the range of $655 million to $660 million, including an approximate $2 million positive FX impact since the last time we reported. We now expect an approximate $12 million negative headwind year-over-year from FX. Our total revenue organic constant currency year-over-year growth is expected to be 8.2% to 9.0%. On a constant currency basis, we’re adjusting down the lower end of our guidance range by $14 million and tightening the range to $5 million. It is now expected to be in the range of $667 million to $672 million. Most of the revision is coming from the services revenue due to the headwinds outlined earlier. We continue to expect non-GAAP gross margin to be in the range of 68% to 70%. We’re also reaffirming our adjusted EBITDA guidance in the range of $217 million to $223 million. We’re likely to come in at the low end of the EBITDA guidance for the year, but we expect to still reach the EBITDA guidance established at the beginning of our fiscal year despite the headwinds to our revenue. We’re able to do that due to our keen focus on the operational efficiency of our business additionally supported by the way we have set up our business to provide natural FX hedges on the cost side that offset the FX headwinds to the top line. Despite the continued evaluation of our cost base, we’re still continuing to invest in future growth of our business and committed to our previously announced strategic investment spend of approximately $20 million this year, which is included in our guidance range. Now to quickly touch on Q4 guidance. GAAP subscription revenue for the fiscal fourth quarter of ‘23 is expected to be in the range of $137 million to $140 million, including a $2 million year-over-year FX headwind. This guidance range represents a 7.0% to 9.3% year-over-year growth rate on a constant currency basis. In conclusion, we’re proud of our year-to-date results and the trajectory we’re on for the rest of the year. Our sales and marketing teams have done an incredible job navigating the ever-changing macro dynamics impacting our customers. We’re also clear on the improvement opportunities internally and have a clear action plan that we’re aligned on. We remain excited about the multiple growth opportunities in front of us and are committed to a balanced approach to growth and profitability, targeting compounding free cash flow growth as our North Star. Thank you, everyone, for joining us today. We look forward to finishing this year strong and updating you on our results and progress next quarter. Mike, starting with you -- hey. Just starting with you, if you could just provide some additional color or maybe some of the deal delays that were mentioned in the prepared remarks with respect to are you seeing them in certain verticals? It sounds like maybe high-tech might be impacting things a little bit more than other verticals. Are you seeing it with like certain sized customers, larger versus smaller customers? Again, maybe just give us a little more color on the deal delays. Yes. And any choppy environment, I think it skews a bit towards larger transactions, become harder to get over the finish line. But certainly, all seen the news in the high-tech with the high-tech companies making pretty significant adjustments across the board. And that’s true, and we mentioned that specifically around our services. We have longstanding relationships with these companies. And sometimes, they say, okay, we’re going to pause a little bit. So, that’s the kind of the primary reason for the services revenue, that and Logistyx we mentioned. But it skews towards larger transactions, and it just takes a little longer for them to get over to finish line that you’d see in kind of any choppy economic environment. Are you seeing any deals actually go away, or are they just being delayed -- purchase decisions just being delayed here? Yes. I think the deals don’t really go away. You either win them, you lose them or they get put off until some period in the future. You have to remember, the reason they put our software in is to fix things for the next 10 years. So many times, we’ll say, well, not this quarter, we’ll see what happens. So I don’t think they really go away. It’s just that they get a stop based on whatever their financial objectives are, whatever they can tackle at certain time. So we don’t really see them going away kind of ever. It’s just a matter of do they push a little bit to the right. Okay. Great. And then with respect to linearity in the quarter, maybe just talk a little bit about any observations there? I mean did you notice that was the slowdown or the deal delays noticed later in the quarter, or was it pretty much even throughout? No. I think we had a strong start. And I think the quarter was a fine quarter. It just -- we had a couple of things that got pushed a little bit. So I wouldn’t say there’s anything kind of different happening than it’s happened throughout the entire year. It’s just a choppy macro environment as everybody can see. Okay. Great. And then, one final question, shifting gears a little bit here. With respect to the Company’s capital structure, maybe you could just give us an update or just give us your -- the firm’s views on, say, M&A versus debt reduction versus share repurchases and how we should think about that going forward? Yes. Thanks for the question. Obviously, we’ve -- as we said, we’ve been able to build the business through a pretty aggressive period of M&A. In the current environment, I think it’s fair to say that that avenue for us is going to be a little bit on pause for a while, primarily because of the bid-ask spreads are a little bit still not where we’d like them. But we also have to be cognizant, Mark, of, one, we have our leverage that is outside kind of our range are coming down. So, we want to make sure we get it back into the range we articulated early on. As you think -- look at our cohorts, we’re undervalued, we think, in the marketplace. So issuing shares at this point wouldn’t be right for us to do for ourselves and for our shareholders. So, I think overall [Technical Difficulty] building our business and generate free cash flow and mostly delevering. First, I would love to dig a little deeper on where we are with your relationships with the system integrators. Sort of what has the initial feedback been for partners as a result of the investment programs? And then, could you give us a sense for how you’re thinking about what impact that partner ecosystem and some of these investments will likely have on subscription revenue ultimately at scale? Yes. I think, listen, we’ve made great progress on the ones we’ve announced. And as we dig in, we find more and more pockets of opportunity in other areas. So, I think we have continual relationships and conversations with them, and they’re getting -- happening at increasingly higher levels in their organizations. You have to kind of keep in mind of how large these companies are, especially when you think about Accenture with nearly 1 million people working for them. It’s going to take a little bit of time, and it’s going to take time for us to kind of build on what we’ve started. So, we -- this is necessary, I think, for us to become the company we desire to become. But we also are very sober in terms of what it’s going to mean and the length of time. We’ve talked about this. This is a really a ‘24 to ‘25 kind of initiative. And that’s why we needed to make a fairly large jumpstart to the investment to kind of get things going. So, we’re excited about it, seeing great progress, but this is not a short-term thing. It’s something we’re very highly committed to. Just to add to that, Adam, as we look towards our next fiscal year, obviously, we’re very focused on working on pipelines and really detailing out the plans together with our partners. And just stay tuned, and you’ll hear more detail as we work through those plans for next year. Got it. Got it. No, that’s super helpful. Thanks for that. And then just on net revenue retention, gross revenue retention, I know these are metrics that you tend to give out annually. Any material changes in those over the last quarter or so from where we were at the end of fiscal ’22, and any drivers of those changes, if any? No. I don’t really see that much of it at all. Those numbers have been pretty consistent for us for a while. So that’s kind of the nature of our business is to retain these customers. So, we don’t really see that changing in the short term. Not a dramatic way, one or the other. I think, Adam, we’ve quantified previously that any quarter, they can kind of fluctuate 100 basis points more or less one way or another, but nothing in terms of change from that prior disclosures or trends. Got it, super helpful. Thank you. And then last one for me, just on the marketing investment. You noticed some outsized performance there. Any scenario that you could see even in a difficult macro environment to sort of amplify the brand to lean in there in addition to what you’ve already laid out, or do you think the benefit from those investments has a little bit left to play out before you consider that? Yes. We make investments in our branding and marketing all the time. And kind of like on the systems integrator, we felt coming out, we needed to put a little more emphasis on it this year, which is why we think a lot of that’s going to be onetime in nature. One of the things that we brought in Kari a little over a year ago, and before that, we never had a CMO. So we have a capability now, and that’s -- that wasn’t part of this onetime investment, but we are making marketing investments, and we continue to expect to be kind of one or two in share of voice, and continue what we started. But we don’t really expect to replicate as much of a onetime spend next year. I don’t think we need to. But it’ll morph back into kind of our normalized sales and marketing spend as a percent of revenue. So just kind of digging in a little bit more into kind of the deal delay commentary. I think last quarter, you were kind of specific to EU, and I think you pointed out the tech vertical also last quarter. Just from a geo standpoint, are you seeing it in more than just the EU kind of from a geographic standpoint? It’s really situational. It just depends on the company, what they have going on and what their approvals are. And like -- just like every company does when things are a bit uncertain is they kind of take a second, third look at things. And it’s a situation that we have some deals that move -- we’re selling a lot of software, some deals move through quickly and other ones that we’d expect to move through kind of get slowed down a little bit. So, I don’t really think it’s any particular pocket. I think, obviously, the tech one is a little bit more concentrated, but we’ve all seen that, right? So, everybody is making adjustments with their plans. And historically, we’ve been -- we have a lot of longstanding tech clients and relationships. Okay. And then just a follow-up on the SI progress you’re seeing or are seeing right now. I think, again, you’ve talked about at least for the second half of the year, SIs being roughly 25% of your pipeline for the balance of the year and actually mentioned that you -- several large deals that you’ve received from them have actually accelerated or progressed to the pipeline faster than if you’re direct. So, is that the case and -- just considering everything that’s going on in the world? And then when should we expect to see actual billings, bookings benefit from SIs that would actually move the needle towards acceleration on organic subscription growth? Yes. Many of the partners we have been partners in the past, and we obviously are making investments to enhance and become bigger partners with them. And again, it takes time with these partners. So, this investment we’re making, again, jump started and to get way more involved and engaged with those companies across the board. And we would see that coming in incrementally over time. And the way to think about our business is you’re not going to see a huge inflection point up for any 1, 2 or 3 things, but all of these efforts we’re doing are really meant to leverage the fact that we have a very diversified product set, the world’s best companies at scale and increasingly a really large ecosystem of network providers and network customers and then also integrators, all just going into the mix of incrementing our subscription revenue, which is our primary focus. So, that’s kind of how we’ve kind of got here and what we continue to do. So you’ll see us actually do this and other things as we go. Again, none of them are going to inflect our business up dramatically. This is all just incremental expansion of our subscription growth at a very high margin. We’ve been extremely disciplined in terms of balancing our growth profile with our profitability. If you kind of look over the past seven quarters now, we’ve been -- have not taken the bait on trying to grow at all costs. We’ve not taken a bait at over investing in things that we don’t think are super sustainable. We’re highly focused on EBITDA, we’re highly focused on free cash flow and highly focused on expanding our subscription revenue that comes in at high-70s kind of gross margin is extremely long term. So, we’re building a long-term business, and we’re going to stay focused on that. Okay. And just last one for me. It sounds like just from a messaging standpoint, the sustainability and durability of EBITDA margins in kind of that low to mid-30% range is kind of the right way to think. Is that a correct takeaway? I think it’s 100% the right takeaway, and that’s kind of -- since we took the business over in 2015 has been really focused on driving high EBITDA margins and incrementing them up over time and expanding them at a rate faster -- growth rate faster than our subscription growth rate. We think that’s the most appropriate way for this kind of business. And there are other business out there that would have a different profile based on where they’re in the business’s life cycle. Our business is one because of the very, very long-term nature of our contracts and the fact that our [Technical Difficulty] primarily mission-critical for the world’s largest -- biggest and most important companies. That just is going to generate the highest return over time for our shareholders, and that’s kind of our -- as Marje says, our North Star. I believe 4Q constant currency subscription revenue growth guide previously implied 14%, so an acceleration. And now the guide implies a deceleration to 8% constant currency. So, can you maybe talk about just what really changed in the quarter relative to your expectations? And maybe provide more color on the assumptions that were down ticked on. And then, Marje, just given the uncertainty, any changes in guidance methodology or additional conservatism that might be embedded in the outlook? Hi Taylor, thank you for the question. Absolutely. So, when we put out guidance 90 days ago, the range of outcomes was much wider. As we commented on the last call, we had seen some select deal delays. As we’ve discussed in this Q&A session as well, specifically sort of in Europe and in the tech sector. As we move through Q3, we saw definitely some of those deals that slipped close, but then further again -- more of them again pushed to the right. And so, as Michael has articulated, this continues to be a choppy environment where we really don’t think that the demand is going away, but it’s definitely getting pushed to the right. And it’s really hard to focus on the specific quarterly growth rates. But as you said, we have lowered our expectation for the Q4. And then, in terms of conservatism, I think you’ve seen how we’ve been setting sort of [Technical Difficulty] we really want to be -- we want to give you the information that we have and the best estimate at the time. So, I wouldn’t say that there is anything sort of unnatural in the quarter. We always try to be transparent. I think that’s the reputation as a management team we’re trying to build is to really be transparent with you in terms of what we see in the business. And as incremental information arises, we will update that accordingly. Great. And then I know the things are obviously very fluid in the environment. But if you look over the last two quarters, sequential subscription rev growth has been in the low single digits. And it looks like the 4Q guide implies something similar. So, just as we think about next year, is it fair to use that sequential growth as a starting point for modeling next year? And anything in terms of seasonality or with the environment in some of these delayed deals that we could -- that we should keep in mind? Yes. I think there is a lot of moving parts. Obviously, we’ve been -- year-to-date, we’ve reported subscription revenue in the double digits. And the macro environment is choppy, so the quarterly growth rates may deviate from quarter-to-quarter. But next quarter, we’ll give you a lot more detail in terms of how we think about the year, and we’ll have further updates on the macro environment, et cetera. But I think it’s too early to fully talk about the year. But, again, just to be super clear, we expect -- we don’t expect the demand that has been pushed out to disappear. We expect these deals to come back, and as the macro stabilizes, come back. And we’ve also talked about our PS revenue growth. We expect that to become additive to our growth rate. So, we feel good about the outlook looking ahead of us. Perfect. And then just my last question is, are you able to quantify the deals that were pushed? And how you’re thinking about timing, let’s say, from that perspective? We haven’t quantified the specific dollar amount. And I think some of the -- as the macro environment changes, again, the time to close just deviates from the normal rhythm that we typically see. So, some of these deals could be just a matter of closing on this side of the quarter or next side of the quarter, right? And we try to make the right economic decisions and not be beholden to our quarter close either, but I wouldn’t say that there’s anything sort of very different that we think we can articulate in terms of beyond the near-term macro choppiness that has changed in our business. Good evening. This is David Ridley-Lane on for Andrew Obin. Curious what the feedback was from the Leaders Forum you held in October. And what was the tone of clients there? And any early indication of kind of client budgets here in calendar 2023? Yes. It was -- that’s a remarkable event. It’s the first one we’ve had for in three -- the first one in three years, and that’s been going on, I think, for seven years prior. And that particular event, just for -- information is oriented towards the very senior executives in a very intimate environment. So we get -- it’s about 90% customers telling what they do on our application and our platform, which is really powerful. I’d say, overall, the environment was certainly very enthusiastic about our relationships. And I always learn a lot. You talked to [Technical Difficulty] have customers. I sat -- had dinner with one that was the world’s biggest producer of frozen fish, and all the things they do for that and how they’re using our transportation managers to help them get fish to market sooner. So, it’s a really great event. Overall, I think people in the supply chain business never cease to try to improve their operations. Companies will never ever stop trying to reduce or improve their gross margin. That’s the fundamental nature of supply chain software. And we all have great ideas. And it’s a matter of how do they compete internally for the projects because the companies only have so many people to do so many things at one-time. And that’s the same as it’s kind of always been in my almost 25 years in the business. In terms of budgets, obviously, everybody is facing the same uncertainties. And I’d say, the macro environment certainly is still a reverberation of COVID, and you see it clearly in the numbers. And I think more -- it’s the uncertainty of what’s going to come that people are uncertain about. And I think that kind of needs to be -- a little more clarity. I think overall, that’s the issue is that we were talking about a recession now for a year, and people don’t know how to really react to that and deal with that. So I think that’s really the hesitancy is really just a continued uncertainty one way or the other. Got it. And just a sort of follow-up on that. I mean, in the past quarters, you’ve talked about pipeline growth exceeding bookings. Are you still adding to the pipeline here even as customers are more cautious? Absolutely. We’ve seen this story before. Demand doesn’t change. The pipeline still goes. Our yield rate maybe come down a notch or two on conversion. But again, they come to us to solve very complex problems. Those complex problems are not for the here now. They’re for the next 15 years. So, it’s just a matter of whatever doesn’t get done today usually gets done tomorrow. And we would expect nothing to change in that kind of a cycle. Great. And then, one last one for me. Just on the Logistyx -- transition for the Logistyx clients. Would that be done -- are we talking another 3 months, 6 months? Just sort of better understanding kind of the headwinds on the professional services side? Yes. It wasn’t an overly large combination for us. It was a $40 million kind of range. And we inherited some things that we had to clean up. And we’re doing that as is our responsibility. And we expect that to last a quarter or two, more maybe, something like that. And then kind of start to normalize out. If I remember, smaller companies usually inherit a little more problems with smaller companies given the nature of their business. That’s something we’re used to dealing with. And it’s something that we’ve had great success kind of fixing over time, and that’s kind of the essence of our business as we make operations better, and we expect to do that here as well. And if it takes a little bit of time, we’ll do it right, and then we’ll have a very longstanding relationship. On the acquisition, I just have to comment, like the opportunity set there is enormous. I was literally talking to one of our larger clients today. And he was talking about a transition from like the on-premise solution that we have to cloud solution. And he mentioned they had something like 120 servers that they were like dying to have us take over. So, we think the global nature of a parcel solution is very differentiated in the marketplace. And that’s really the primary reason we really liked that company when we saw it and knowing that we had to deal with some stuff to get to the other side. So, we have a very unique solution that combines with our really great solution or TMS and global trade and also international shipping via our bookings platform. So, we’re really building what we believe is the world’s best logistics execution system. And I couldn’t be more excited about where we are with that. Yes. I wouldn’t say it’s incrementally better or worse. I think I understood the question of, is it incrementally better or worse, Fred? You took that a little bit. I wouldn’t say it’s incrementally better or worse. I just think it continues to be [Technical Difficulty] uncertainty and how companies deal with that uncertainty. Certainly in the tech environment, you see it, but you really see it real time every day. And companies certainly starting to taper and starting to say, okay, I’m not going to invest in everything all at once. I think that’s the only thing that I would say has kind of more firm up. The rest of it is the same chop we’ve seen for really three quarters now. Got it. And then -- and just another question on how competition has been behaving, especially some of the venture backed start-ups that might not have as strong a balance sheet. Are they acting any less rational than they have historically? Well, when you don’t have to generate a profit, you can do a lot of irrational things in the venture -- stays close to kind of -- are able to essentially subsidize their business. So, that’s not new, though. This has been the case for a long time, and that’s the market we participate in. So, we don’t see them acting any more or less normally than the way they do. And that’s just part of the market. And we believe we have obviously a more sustainable business model because we generate [Technical Difficulty] Sorry about that. Just one final question for Marje. Can you hear me? Just one final question for Marje on RPO. I know there’s some acquisition always in there, but the $795 million apples-to-apples, what was that growth year-over-year? So, the number is -- obviously, it’s pro forma for acquisitions. So, when you look at the year-ago number, I think -- I don’t know it from the top of my head, but I think it was around $731 million versus the $795 million this quarter, so around 8% growth rate. We have reached the end of the question-and-answer session. This concludes today’s conference, and you may disconnect your phone lines at this time. Thank you for your participation.
EarningCall_1494
Good day and thank you for standing by. Welcome to the Photronic's Fourth Quarter and Full Year 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded Tuesday, December 13, 2022. I would now like to hand the conference over to your host, Richelle Burr, Executive Vice President, Chief Administrative Officer and General Counsel. Please go ahead. Thank you, Richelle. Good morning, everyone. Welcome to our review of Photronic's fiscal 2022 full year and fourth quarter results. Joining me to [indiscernible] evaluate ongoing performance and reconciliation of these metrics to GAAP financial results is provided in our presentation peril. Thank you, Richelle, and good morning, everyone. Q4 was solidly finished to a great year. Revenue grew 24% in 2022 as we achieved our fifth consecutive year of record revenue. Both IC and FPD generated strong growth as design activity remained robust. We saw annual growth across nearly all products types. It remains clear that our broad technology portfolio, operation effects and close customer relationships have met us the market leader. Q4 revenue was less than third quarter revenue, with demand slowing in high-end large lastly. Our investment will be indicated by the current semiconductor industry downturn as design activity remains relatively strong. There was also some negative impact from depreciation of Asian currencies on FPD business. However, we believe that factor causing this slower demand with the transit, and we maintain our positive view on the long-term demand trend. Gross margin and operation margin was essentially flat compared with the third quarter as we motivate the impact on lower borrowings by closely managing our costs while we continue to benefit from strong pricing. We also realized a foreign exchange gain that John will discuss in more detail later. The end result is we delivered EPS of $0.60 for fourth quarter. Looking now to the industry outlook while we believe the demand trends in addition to customer capacity expansions are intact in the long term. The near-term picture is cloudier due to current market on service. Factors such as high interest rates, rising inflation and slowing GDP are already having a negative impact on some sectors of the electronic product supply chain and could potentially impact photomask demand. Moreover, adding to uncertainties is that U.S. government's new export restriction imports from China on certain semiconductor technologies that may further impact the Chinese IC industry. So far, these actions have had minimal impact on Photronics' business or operations. However, the situation is dynamic and through, which we continue to monitor. At the same time, we will ensure our compliance with all regulations while taking necessary actions to mitigate the impact on our supply chain and business. Although the near term deal is uncertain, we are confident that IC design and manufacture continue to play a central and expanding role in the global economy. Photomask is a key element within the ecosystem. We are continuing to strive over the long term. Currently, IC manufacturing regionalization is spurring investment across the world. This new capacity will generate additional photomask demand. Performance will capitalize on these opportunities from a position of business and spread. Our customer relationships are beyond trust, supported by our technology, service, quality and global production capacity. This customer relationship coupled with many long term purchase agreement have continued to support our competitive advantage in the business. I would like to thank the entire Photronics' team for excellent performance in the fourth quarter and throughout the full year. We navigated challenges and change and great opportunities as we deliver another record year. Our long-term strategy is intact and on track to achieve our financial targets. I'm proud of what we have accomplished together and believe we can do even better in the future. Thank you, Frank, and good morning, everyone. Revenue in the fourth quarter was lower sequentially as softer demand trends were experienced in both IC and FPD primarily for high-end products. Our product diversity and global customer base helped mitigate high-end [indiscernible] with mainstream revenue higher for both IC and FPD. We have invested in tool sets for a broad array of technologies and nodes, enabling us to support our customers' technology road map across both high-end and mainstream. As a result, fourth quarter revenue of $210 million was down only 4% sequentially despite the declines in high-end product revenue. Our conversion teams have done a great job of working with customers to identify opportunities, and our operations teams were effective in supporting this demand with on-time execution, delivering the highest quality products that enable our customers' success. IC revenue of $156 million in the fourth quarter was up 25% year-over-year and down 3% sequentially. Although high-end revenue was lower quarter-over-quarter due to some reduction in agent foundry logic demand. That business has been significantly better than last year's fourth quarter due to some increases in capacity through the year. Midstream revenue improved on continued strong demand, especially in Asia. FPD revenue of $54 million was down 8% quarter-over-quarter and 3% year-over-year. Demand from mobile display masks was lower as panel makers focus on purchasing current products for new premium smartphones and not releasing new designs. G10.5+ demand was also lower during the fourth quarter. We were successful in picking up mainstream [indiscernible] to maintain higher capacity utilization. Gross and operating margins were essentially flat in the third quarter as improved pricing and continued cost discipline offset the negative impact of lower volumes on operating leverage. Gross margin of 38.2% and operating margin of 28.8% are already within our target model range. Based on our outlook and the continued focus on cost reductions, we expect to continue to deliver margin improvement as our revenue moves into the targeted zones with price increases holding stable in 2023, while the outlook for continuation of premiums may be the certain. Operating expenses decreased compared with the third quarter as we balance the need to maintain margins while also investing in [indiscernible] resources to support revenue growth, positioning us to continue to grow both revenue and profit. Non-operating income of $11 million was primarily due to FX gains primarily resulting from re-measurement of U.S. dollar-denominated balances in following locations into the local functional currencies. Income tax provision of $16 million resulted in an effective tax rate of 25.5% for the fourth quarter and 25% for the full year. Diluted EPS for Q4 was $0.60, an 18% increase over Q3 and 82% increase over the $0.33 of last year's fourth quarter. Diluted EPS for the whole year of 2022 was $1.94, an increase of 118% over 2021, demonstrating the achievement of the entire Photronics' team during a challenging and changing year. Cash flow generated from operating activities from $79 million in the fourth quarter bringing the 2022 total operating cash flow to $275 million. We used this cash to invest in growth by funding capital expenditures of $66 million in the quarter. Full year CapEx was $109 million, net of nearly $4 million in government subsidies. For 2023, regional CapEx to be approximately $130 million as we continue to invest in growth, primarily for high-end and mainstream IC capacity. We also continued to reduce debt during the quarter, bringing total year-end total long-term debt to $42 million, a reduction of $69 million since last year-end. Cash balance at the end of the quarter was $320 million. If we improve short-term investments of $39 million, net cash and short-term investments at the end of the quarter was $316 million. Our balance sheet is strong and flexible, and we're able to pursue growth investments, both organic and inorganic also being prepared to weather potential future economic challenges and uncertainty. Before I provide guidance, I'll remind you that our visibility is always limited as our backlog is typically only one to three weeks and demand for some of our products is inherently uneven and difficult to predict. Additionally, the street high-end masks are high. And as this segment of the business grows a relatively low number, high-end orders can have a significant impact on our quarterly revenue and earnings. Given those caveats, we expect first quarter revenue to be in the range of $203 million to $213 million as we expect positive demand trends with less than typical seasonality. Based on those revenue expectations and our current operating model, we estimate earnings per share for the first quarter to be in the range of $0.40 to $0.48 per diluted share. 2022 was a great year. We grew revenues 24% posting our fifth consecutive year of record revenue, expanded margins, which places us into the bottom end of the range in our target model and strengthened our balance sheet, generating cash, reducing debt and investment in growth. Looking forward, we believe positive long-term market trends and our leadership position together with financial flexibility positions us to continue our profitable growth and achieve even greater success for our customers, our employees and our shareholders. [Operator Instructions] Our first question comes from the line of Hans Chung with D.A. Davidson. Your line is open. Please go ahead. So first, so it seems like you have a pretty good gross margin for the quarter. And then just wanted to kind of deep dive back what's the driving factors that I know you mentioned some cost management and then the pricing is still favorable. So just any detail on that? And then how should we think about the gross margin in 2023? The pricing environment has been very good, so our pricing is stronger than it has been historically. And we expect that pricing to maintain. We've seen even as demand is still strong, but not quite what it has been. The pricing holds up, we have pricing agreements across the Board in Asia, they've held, as I mentioned, as demand is not quite as strong. We did -- we have had premiums as people gain [indiscernible] to move up in extra from mainstream delivery sense has been much more extended than it had been historically. Those premiums are less predictable, but through the fourth quarter, both pricing and premiums have held up. So a combination of change in mix with some of our operations taking up business and improving their margins and with sustained pricing strength, we think we will stay within the margin ranges that we've been experiencing. Okay. And then next question, just I know you mentioned the recent impact from China, the restriction that minimized our business. So -- but you also mentioned there is still some uncertainties. So I just wanted to kind of get more understand the index, what's the potential risk from new China export control? Or is any indirect impact from that? So far, Hans, we've been -- there are a couple of factors. One is our business in China is primarily mainstream. So -- and most of the restrictions that are issued to prevent leading-edge technology from leaking into Chinese military primarily. So those restrictions to some extent, have affected us, but we've been able to essentially figure them all to understand and work with them. So, the restrictions have affected us very over the past three years since they started imposing them. I think that if they stay in the leading-edge technologies, we're going to remain unaffected but we spend a lot of effort to understand the restrictions as they're imposed and to make sure that we reach today with them a lot. So, so far, not much effect. There has been some, but very minimum, and we expect that to continue. And as restrictions continue to get issued, we'll continue to assess how they affect our business and work within new restrictions. Hopefully, we'll continue to experience the same minimum effect that we had because they're directly primarily at leading-edge technologies where we're not engaged. This is Chris. I might add one thing to that on the -- if there is a positive side to this since the leading edge has been kind of restricted in China, a lot of that capacity can deploy to midrange and mainstream. So that's creating a fairly healthy design pipeline have been ranging mainstream nodes in China. I'm just seeing that in the local facility. So -- and those are sweet spot nodes for us, particularly how we're tooled up there. So that's kind of a situation. But fortunately, that's kind of a positive knockout effect for our local business. Thank you. And one moment for our next question. And our next question comes from the line of Gus Richard with Northland Capital Markets. Your line is open. Please go ahead. About six months ago, to pan photomask was spun out and sold to private equity. And I'm just wondering, given that transaction been a little bit of time, how has that affected the market or hasn't it? This is Gus. Real quick. To pan photomask that spun out about six months ago. It's been in that state for a while now. And I'm just wondering how is that impacting the photomask market? Or is it -- or as things remaining the same? Gus, Thank you. Basically, we don't see a major change in the business model, [indiscernible] since their spin-off they have made major capital investment even announced some projects in Texas, but nothing materialized. So at this moment, from customer side, from our side, we haven't seen a real difference. Got it. And then in terms of the $130 million in CapEx, can you provide a little bit of color? Is that for de-bottlenecking? Or are you going to get some high throughput tools for mainstream? Is it going to be for high end? What -- can you give a little color on where you're investing? Sure. Actually, in the past 15 months, the equipment data in photomask is also very long, same as in semiconductor business. So some tool will actually ordered one year and half ago. So the tools are coming in is, main progress of this tool is to serve the mainstream business expansion and also we don't have some tools which are going to the end of life. So we are doing certain tool replacement in addition to mainstream business expansion. However, the tool to be repressed our old tool, so the new tool has a better performance, higher throughput. So, we expect not only just a replacement, we will see some new capacity added to our overall production capacity. Got it. And then the last one for me. You talked a little bit about demand softening a bit. Can you put that in context of lead times, lead times have stretched quite a bit from days to, I think, weeks or months. How has lead time changed over the course of the quarter? The soften demand actually stated two, three months ago, particularly in the high-end side. But it doesn't really impact our fab utilization. We still have enough work. But of course, this time to customer has been reduced because the VAT level is lower. However, there are certain signs -- the demand for the high-end is coming back. At this moment, we -- it's a little bit too early to be very precise in terms of green recovery. But from our input from sales and customer, we do see the high-end level start to come back. Thank you. And I'm showing no further questions at this time. And I'd like to hand the conference back over to Frank Lee for any further remarks. Thank you, Richelle. Thank you for joining the meeting. I'm very pleased with our performance in 2022 and proud of the way our team has responded to the [indiscernible] and changing environment. We are well positioned to continue our success in the future and looking forward to updating you as we continue to make progress.
EarningCall_1495
Good afternoon and welcome to the Mission Produce Fiscal Fourth Quarter 2022 Conference Call. [Operator Instructions] Please also note today's event is being recorded. At this time, I'd like to turn the conference call over to Jeff Sonnek, Investor Relations at ICR. Sir, please go ahead. Thank you, and good afternoon. Today's presentation will be hosted by Steve Barnard, Chief Executive Officer; and Bryan Giles, Chief Financial Officer. The comments during today's call and the accompanying presentation contain forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical facts are considered forward-looking statements. These statements are based on management's current expectations and beliefs as well as a number of assumptions concerning future events. Such forward-looking statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from the results discussed in the forward-looking statements. Some of these risks and uncertainties are identified and discussed in the company's filings with the SEC. We'll also refer to certain non-GAAP financial measures today. Please refer to the tables included in the earnings release which can be found on the Investor Relations website, investors.missionproduce.com, for reconciliations of non-GAAP financial measures to their most directly comparable GAAP measures. Thank you for joining us for our fourth quarter and full year fiscal 2022 earnings call. We achieved an important corporate milestone in fiscal 2022, generating $1 billion of revenue for the first time in our company's nearly 40-year history. We grew our full year revenue by 17%, driven by an extremely robust pricing environment, where our average selling price was up 28%, which was supported by low industry volume out of key sourcing regions such as Mexico. While the strong pricing was in place for nearly the entire fiscal year, trends reversed sharply during the fiscal fourth quarter with the onset of the new Mexican season and drove prices down approximately 35% as compared to the fiscal third quarter. While this sequential softening was anticipated, the speed of the decrease was greater than expected and drove our average price down 10% for the quarter versus the prior year period. As we've noted previously, our business is driven by volume and in an otherwise normal environment, lower prices tend to drive incremental consumption, particularly in the newer emerging markets. However, this environment is anything but normal. While our fourth quarter volume increased 6%, our financial performance was impacted by a confluence of variables that undermined our ability to drive the per unit margins that we have generated historically. Persistent cost inflation, combined with the impact of a La Niña weather pattern that drove a bigger crop with a greater mix of larger fruit that we planned for within our own production, resulted in a delay to our seasonal transition to the Mexican production. Further, we did not have the normal benefit of the California crop in the fourth quarter, which was pulled forward this season as growers took advantage of the high pricing environment. This resulted in an unfavorable mix, lower relative pricing and temporary margin compression. Taken together, this presented a significant headwind for our per unit margins, which were well below our expectations and drove a 35% decrease in our fourth quarter consolidated adjusted EBITDA. That said, the numbers don't necessarily demonstrate the significant inroads we made with our Peruvian programs and the strategic advantages that affords us. During the 2022 harvest season, we converted several retailers to the Peruvian product for the first time. While the market environment was disruptive to our ability to capture the margin we traditionally expect, it was an ideal set of circumstances to demonstrate the value of our global sourcing network. Retailers were keenly aware of how the short industry supply led to high pricing and sought out alternatives, through our vertically integrated production, we were able to establish programs with our retail customers where we can commit to substantial volumes of product at attractive price points. These programs are a huge win for Mission in a broader sense. We are deepening our relationship with major retail accounts through sound strategy and execution, demonstrating new pathways to drive profitable sales across their enterprises. We also reinforced the quality and consistency of our production with their consumers, which builds trust and opens future opportunities; and finally, we improved awareness and established a trusted alternative during Mexico's off-season. Mission's ability to deliver consistent high-quality fruit during the Mexican off-season is a clear advantage of our vertical integration and is an example of how year-round sourcing capabilities are helping expand the avocado market. Supporting our global footprint remains critical for our growth strategy. We are leveraging our vertically integrated global supply chain and distribution capabilities to continue developing international markets. We are bringing our network of complementary assets that cover North America and Latin America to bear and are building on our presence in Europe as well with addition of our hub in England. We have our team in place and they are on track to open this new facility later in our fiscal second quarter right in time to service the Peruvian harvest season. The facility of strategic location provides Mission with a unique access to the growing market in the United Kingdom for avocados, while simplifying imports, logistics and expediting transit times. We've been working with retailers in the UK to grow the category direct access to high-quality right product to our source and distribution capabilities. Our vertical integration from our scale of production in South America positions us well to provide the European market with a year-round supply of high-quality avocados and we aim to propel the avocado category forward in Europe just as we have in the U.S. market. In Asia, we are leveraging our more than 35-year presence in Japan and existing Chinese distribution facilities to serve as a platform to build our Asian distribution network. Both of these regions present immense long-term growth opportunities for us with consumption rates that are a fraction of what the U.S. has grown into today. Ultimately, our ability to execute this consistently comes back to our year-round sourcing capabilities, which are extremely unique and a substantial competitive advantage for Mission. Our goal is to grow our access globally with consistent year-round supply. This is the key to supporting long-term consumption growth and is the catalyst to drive new market development. Mission has played a critical role in the industry's growth. It has required foresight and a constant focus on continuously -- and continuously assessing opportunities to optimize our sourcing capabilities with third-party growers as well as investing in our own farms to provide greater control over the quality and supply that our customers have come to expect. With respect to fiscal 2023, we see a more normal marketplace emerging, highlighted by better and more consistent supply conditions, which provides a constructive foundation for the industry to drive consumption and expand growth in new geographies. We are prepared to meet demand during the upcoming peak Super Bowl season and expect to produce improved operating performance for the full year in 2023. Thank you, Steve, and good afternoon to everyone on the call. I'll start with a brief review of our fiscal fourth quarter performance and touch on some of the drivers within our three reportable segments. Then I'll provide a snapshot of our financial position and conclude with some thoughts on the current industry conditions that we are seeing. Total revenue for the fourth quarter of fiscal 2022 were essentially flat to the prior year at $238 million. However, note that current revenue was advantaged by approximately $10.5 million due to the blueberry consolidation that took place this year, but isn't reflected in the prior year period. When looking at the drivers of our avocado business for the quarter, revenue was driven by a 10% decrease in average per unit avocado sales prices, due to a combination of higher industry supply and were exacerbated by an unfavorable mix of larger fruit from the company's own production in Peru. Avocado volumes sold increased 6%, primarily due to the company's larger Peruvian harvest as well as greater Mexican volume, partially offset by lower volumes from California. Fourth quarter gross profit decreased $6.9 million or 20% compared to the same period last year to $26.9 million and gross profit percentage decreased 296 basis points to 11.3% of revenue. The decrease in gross profit was primarily driven by lower per unit margins in both the international farming and marketing and distribution segments. International farming segment margin was impacted primarily by significant cost inflation, including logistics, farming and packing expenses. These increased expenses accounted for nearly $0.15 per pound, or approximately $3.50 per box. I would note, however, that we are seeing some signs of easing pressure on refrigerated ocean freight, which tend to lag that of dry containers. We aren't contracted yet and we are watching this closely, but do expect some year-on-year savings in the coming year, which is encouraging. Marketing distribution segment margin was pressured by the sharp deceleration of industry prices during the quarter and was lower than our targeted range. Further, we also experienced an impact on our per unit margin due to our lack of California fruit during the quarter. SG&A for the fourth quarter increased $4 million to $19.5 million due primarily to higher employee related costs driven by higher stock-based compensation expense and labor inflation, as well as non-capitalizable ERP implementation costs and non-recurring process reengineering costs related to the ERP system in our marketing and distribution segment. The consolidation of Maruga increased SG&A by $1.2 million, which included amortization of an intangible asset recognized acquisition. Net loss for the fourth quarter of fiscal 2022 was $42 million or $0.59 per diluted share, compared to net income of $16.9 million or $0.24 per diluted share for the same period last year and includes a non-cash charge of $49.5 million related to goodwill impairment within the international farming segment, which I will comment on my discussion of the segment performance. Similarly, adjusted net income for the fourth quarter of fiscal 2022 was $9.2 million or $0.13 per diluted share compared to $17 million or $0.24 per diluted share for the same period of last year and adjusted EBITDA was $17.2 million for the fourth quarter of fiscal 2022 compared to $26.4 million for the same period last year due primarily to lower per unit gross margins and higher SG&A costs noted above, partially offset by the impact of higher avocado volumes sold. Turning to our segments, our marketing and distribution segment net sales decreased 4% to $221.2 million for the quarter and segment adjusted EBITDA was $4 million. The drivers for the marketing and distribution segment are similar to those that I described for the consolidated results, in relation to pricing volume per unit margins and SG &A. Our international farming segment primarily represents our own farms that we manage in Peru. Substantially all sales of fruit from the international farming segment are to the marketing and distribution segment with the remainder of revenue largely derived from services provided to third parties and the blueberry segment. Affiliated sales are concentrated in the second half of the fiscal year in alignment with the premium avocado harvest season, which typically runs from April to August of each year. As a result, you see the international farming segment emerge in third and fourth quarters and contribute to adjusted EBITDA in a significant fashion. So with this in mind, total segment sales in the international farming segment increased $9.4 million or 31% for the quarter compared to the same period last year due primarily to higher affiliated sales due to an increase in avocado volume harvested and sold. Segment affiliated sales reflects the consideration return to the international farming segment, net of logistics costs, the most significant of which is ocean freight. When considering higher logistics costs along with rampant inflationary pressure across our growing operations, our margins suffered as a result. Segment adjusted EBITDA was $12.2 million, a 32% decrease from prior year, primarily due to lower per box margins driven by significant inflation, including logistics, farming and packing costs. While sales pricing was comparable to prior year, an unfavorable mix of larger fruit inhibited our ability to drive pricing higher. During the fourth quarter of fiscal 2022, we recorded a $49.5 million non-cash impairment loss to reduce the carrying amount of goodwill associated with our Peruvian reporting unit within the international farming segment. Combination of variables, including inflationary impacts on our cost structure, increasing interest rates and higher inactive corporate tax rates in Peru unfavorably impacted the discounted cash flow forecast for our Peruvian farming operation. As Steve said in his remarks, despite this turbulence we have recently experienced, we firmly believe that the investments we are making in our Peruvian farming operations are integral to supporting our customers and our long term strategy. Our Blueberry segment reflects the results of Moruga's farming activities, which includes cultivating early stage blueberry plantings and harvesting mature bushes. This product is marketed globally by our partner in the Moruga joint venture. For the fourth quarter, our Blueberry segment net sales were $10.5 million and segment adjusted EBITDA was $1 million. As a reminder, sales in our Blueberry segment are concentrated in the first and fourth quarters of our fiscal year in alignment with the Peruvian blueberry harvest season, which typically runs from July through January. Although relatively small in size, the blueberry harvesting season is asynchronous with the avocado harvesting season, allowing us to leverage our resources and Peru during the off season for avocados. Shifting to our financial position, cash and cash equivalents were $52.8 million as of October 31, 2022, compared to $84.5 million at our prior year end. Net cash provided by operating activities was $35.2 million for fiscal year 2022 compared to cash provided of $47 million in the same period last year. Despite our weaker income performance, we were able to limit the effect of our operating cash flows to less than $12 million due to reductions in working capital, which were favorably impacted by lower per unit fruit pricing toward the end of our fiscal year. Capital expenditures were $61.2 million for the fiscal year ended October 31, 2022, compared to $73.4 million last year. Current year expenditures were concentrated on the purchase of farmland in Peru as well as land improvements in orchid development in Peru and Guatemala. Capital expenditures within our marketing and distribution segment were much lower following the completion of our Laredo facility in the prior year. Looking ahead to fiscal 2023, we expect CapEx related to our core avocado business to be lower than fiscal 2022 with reduced investments in our farming operations in Peru being partially offset by spend associated with the construction of our new UK distribution center. That being said, we will incur additional costs as we ramp up development of the Moruga blueberries project in the almost region of Peru. In terms of our near term outlook, we are providing some context around our expectations for industry conditions to help inform your modeling assumptions as the business shifts back to the marketing and distribution segment. The industry is expecting first quarter volumes to be higher than prior year, primarily due to expectations for a larger Mexican harvest. We expect the overall Mexican crop will be approximately 20% higher than the prior year harvest season, but early season volumes are currently lagging that figure due primarily to low pricing in the market. We expect prices to be lower on a sequential basis, but consistent with pricing experienced in the latter part of the prior quarter. On a year-over-year basis, we expect to see pricing down approximately 20% to 25% as compared to the £1.56 per pound average we experienced in the prior year first quarter. As for our cost structure, we continue to battle the same inflationary pressures that have been well documented. These include freight, labor and packaging costs, among others, which create headwinds to our ability to drive pre unit margins and adjusted EBITDA. Hey, thanks for answering my questions. So I want to ask you noted that there's still some lingering pressures from costs into the fiscal first quarter. What is your line of sight to that margin pressure alleviating and you getting back to your targeted margin per box range? Or maybe ask a different way, what do you need to see from an external environment to get back to that normal range of margin? Stability comes to mind. Ben, I think one of the things we're seeing, when we talked about inflation in the fourth quarter, the most significant impact was really on the farming side of the business, probably more so than our marketing piece, but there's no doubt that there are cost pressures that we're seeing there in terms of some of the overheads that we're working with. I think in terms of the buy-sell on the fruit, which is probably going to -- which is typically the primary driver as to what our ultimate per box margins are on that marketing side of the business, I think right now what we would like to see to Steve's point is a stable environment, stable pricing. I think we're starting to settle into that, but we're at very low price points right now. I think we would like to see some uptick in pricing, particularly as we move towards the Super Bowl. And again, as we've mentioned in the past, our volume does tend to be backloaded in the first quarter during that ramp up. So I do think that it's tough for us to make too many judgments on what we've seen so far in the early part of the quarter. I think we're still hopeful that as we kind of move through it that -- that the margin environment does begin to improve. Okay. I want to ask about the impairment charge. Can you talk in a little bit more detail about what drove that impairment and kind of what the moving pieces are there? Sure thing, Ben. I think that the things that happened in particular as we moved into kind of through the third quarter and into the fourth quarter, the market conditions that we're dealing with much higher cost of borrowing, much higher weighted average cost of capital associated with the rising interest rates. And again, when looking at goodwill, we have to look at discounted cash flows, not just absolute. We combine that with kind of what we saw in the sales market as we transition to the fourth quarter. I think we were experiencing cost inflation throughout Q3 and Q4, but in Q3, our average selling prices of fruit were significantly higher. And I think probably we and -- we had a much more comfortable at that point that the higher sales prices were absorbing that cost growth. I think the decline that we saw in Q4 caused us to kind of be -- maybe scrutinize things a little more closely. And I think we wanted to be maybe a little more conservative in how we modeled going forward. So that certainly impacted the cash flows or our cash flow modeling. I will say the one other thing that's out there that actually happened in 2021 was the rising tax rates in Peru. Now that was something that didn't necessarily drive an impairment in the prior year, but it certainly consumed a significant amount of the headroom that we had when we looked at the valuation of that business. So. I think those were kind of the primary drivers. I will say kind of on the back end that a lot of this goodwill came on the books in 2018 when we bought out our partner's interest and we didn't have an active liquid stock of Mission at that point in time and that was really the currency that that was used for making the acquisition. So, in hindsight, there was probably some debate over the value that was assigned to Mission shares versus the farming operation right from the get-go that we probably carried forward. Okay, just one more for me. I know you're not guiding specifically to EBITDA for 2023, but you did talk about I think you mentioned do you expect improved year-over-year performance and earnings. Just so you can give us rough goal post, are we thinking getting back to 2021 levels, getting back to 2020 levels, I know 2019 was exceptionally elevated, but just to help us set very rough parameters on kind of the slope of recovery in the business that you're currently expecting. At this point, Ben, I don't think we're really prepared to provide anything too specific for the year as a whole. When we look kind of at a high level, I think that volume -- we do expect volumes as we said at the industry level to be much stronger out of Mexico this year and Mexico is still the primary country of origin for the fruit for that we work in both in the U.S. and abroad. So we do expect there to be kind of favorable tailwinds from the volume growth. I think we certainly, in the first quarter last year, had some one-time cost related to ERP that we think we put behind us when we moved into Q2. We don't expect that or would not expect that to recur this year. On the flip side, I think as we moved through the middle of this last year, we also saw very strong margins, particularly out of California with the very high price points. And I'm not sure if we have a more moderate pricing environment coming forward into this next year if that may have some offsetting impact. So it's tough for us at this point to really define exact parameters. I think that with volume growing, it will improve our capacity utilization, but we still will have capacity to grow far beyond, I believe where we're going to get to this year. So I think that'll continue to be a little bit of a drag and may cause some pressure that would prevent us from getting back to maybe where we were in prior periods. But I think the most important thing for us is to see stability, so we can start to kind of model on the marketing side of the business what things might look like kind of as we move towards the back end of this first quarter. I think on the farming side, it's really kind of early for us. I think we're -- we don't have a complete estimate yet of what our farming production for the upcoming season is going to be. I think we'll know more as we kind of get to the end of the first quarter and then certainly kind of looking at the dynamics at play with the other countries of origin to get a better sense as to what we think average selling prices might look like next summer. Hey, thanks for the question. I wanted to maybe first just follow-up on the Peru impairment. Bryan, you highlighted kind of the factors that contributed to it being the higher cost of capital, the tax rate change, the lower earnings in the inflationary environment, the second half of this year. To what extent I didn't hear mention, I guess, and I'm wondering to what extent this is a factor. Did you lower your earnings expectations above and beyond that tax rate change for future years? Was that a big factor or was it more of those other items and therefore kind of the underlying profitability this business is still largely maintained. I don't have all the calculations in front of me, Tom. I do know that the higher tax rates had a significant impact. I know that the higher weighted average cost of capital, which was 2.5 percentage points higher than what we were using back when we originally put the goodwill on the books had a meaningful impact kind of applying that over a very long period of time. I do think that, when we're looking there, there's certainly a recency bias and kind of looking at what happened this year where overall for the season, our average pricing on Pure is very comparable to what it was last year on a sell through, but we looked at a much higher cost structure and I think what we're debating internally is certainly is how that cost structure is going to come back down. I think there's some things where we're already starting to see that, but we don't know at what pace that reduction is going to happen, for example, with something like ocean freight. I think with other items in our cost structure, things like fertilizer, we've also seen significant ramp ups and I think the key on some of those areas is to continue to drive up the yields per hector to try to absorb those costs as we continue to kind of wait for more favorable market conditions to I think as we move into future years. but I think it was difficult for us to predict exactly when those things were going to happen and I think we felt a little uncomfortable taking very aggressive positions on that within our modeling. Okay, thanks for that. Understood. You had some info in the 10-K on the planned blueberry build out just the overall cost. How does the cost to plant blueberries compared to the cost to build out acres for avocados? Is it comparable? I don't know the exact numbers, but it's a lot more expensive on the development side of it because you've got proprietary plants that another nursery grows compared to the avocado trees, which we grow ourselves and use the seed stock and the top stock from our own ranches, but these are all proprietary varieties which cost a lot of money up front, but your production from what we've seen so far on these new varieties are over double of what the old varieties were and you can get a much higher sales price for them, especially in places like Asia. So, I don't have the exact numbers on them. It's relevant though. We're using the same people. It's kind of the same logic that we did earlier, except it's on a different ranch up north, which the timing comes off differently. So we're kind of spreading it out a little bit. Understood. Thanks. And then I just wanted to follow up on our comment you made about margin pressure due to a lack of California avocados. Could you maybe just elaborate on what you meant by that? Sure, we generally make -- from a contribution margin perspective, the country of origin where in our marketing business where we tend to make the highest margin is with California when we're sourcing fruit here and running through our Oxnard packing house. In a typical year for California, we're harvesting well into September, maybe even into October and selling California through -- fruit through the entire quarter. So we're getting a benefit in that fourth quarter of having that California fruit as part of our sales mix. I think what we saw this year is because of the high prices, most California growers completed their harvest much earlier than normal. We finished packing here at our facility the first week of August. So we had very little volume -- selling volume that flowed through in our fourth quarter and I would say that that was when we're talking about a favorable impact. it was more of a mixed based comment that I'm not having that California sales in there that's a higher margin to kind of bump things up relative to last year. Thanks operator. Good evening, guys. So I guess just a more higher level question with regards to costs and maybe this is more relevant for the international farming segment than marketing and distribution, but, I guess my question is just to the extent that there are higher non-fruit related costs, like overheads, labor. freight shipping like to the extent that this -- these elevated costs are more structural, if you get to that point, if that's the conclusion you’ve drawn, does that change the way you need to approach pricing with retailers to get back to sort of a stability but also getting back to a profit for box. I guess what's underneath my question is just for most of the companies we follow who are especially experiencing this with their upstream suppliers, what's happening is that their upstream suppliers are coming back to the vendors and saying, our labor costs are permanently higher. We think transportation is going to be permanently higher and so whatever a pass through was right, there's an overhead component that's being adjusted upwards and I guess, it's just I guess my concern or my question is just it's a lot of these costs are going to be more permanent, do we need to have a maybe a different sort of reset in terms of how you think about pricing with retailers because it's more than just the volatility of the fruit. I hope that's clear. No, you're absolutely right. We have to continue to pass it along or we're not going to be here very long. So, a lot of these contracts were set up early last year on freight. Fertilizer kept going up as the year went along. Labor kept going up as the year went along. As Bryan mentioned, the tax change in Peru, so it just kind of all boiled up. It just weren't an adjustment period now and we'll continue to adjust to get it right, but it's kind of creeped up on us. Yeah, I would say Bryan on the marketing and distribution side of the business, it's probably easier place to start. Absolutely, and I think we're already pushing we're building that into our costing models. We've been doing it and we're pushing for higher pricing with retail, I think in environments where those kinds of costs are increasing, the advantage on the marketing side of the business is we can either work with the customer for higher pricing or we can work back with the grower to drive our input costs down. So it does give us a little more flexibility there. We're aware of it, but I think certainly at times when these things are going up, margins do tend to get pinched a little bit, but we don't view that as a long term phenomenon and we view it more as a short term. I think when we look at the farming side of the business, we certainly we can see the cost growing. We don't have an ability to really lever like a fruit input cost like we do with the marketer. So the price with the customer is really the primary lever we have to drive margins for when we're dealing with costs that we don't have direct control over. I think that over the long term, I think the way you're saying explaining it is absolutely going to come true. There will be a balance of supply and demand and price points will settle in at a level that affords a reasonable profit to the growth, but in a short term market, like what we saw in the fourth quarter, that doesn't necessarily hold true. If the supply at that point, you've got fixed cost invested in the supply of the avocados is there and the market's going to determine what they're going to pay for those, but I do believe and I believe very strongly, we both believe that over a longer period of time that will settle in at a higher price point if those costs don't come back down. Yeah, okay. So just maybe to tie that up right again from the seats we're sitting in because we can't see all these costs right. We can see the movement in avocado pricing and I think it gets back to maybe Ben's question earlier, is we're thinking about getting back to a kind of a more. whatever normalized profit per carton or profit per box. It's going to take some time because you're not really I guess it sounds to me like it's really determining how much of these other overhead costs are going to be more permanent and how much are not and so that dialogue you're going to have with your customers to sort of dial that in right or correctly, it's just going to take time. I think your spot on that, Bryan and, there's just -- the things that are driving our cost structure are not -- they're not directly correlated today with what's going to drive sales pricing of avocados in the short term. Again, over a longer period of time, they absolutely will, but I think it takes time to adjust that and I think I don't want to downplay the impact. I know Steve mentioned that the size curve, we ended up with -- we had much larger fruit that we were marketing this year that has -- it limits the outlets for it to some extent. There's retail once were primarily a certain size of avocado, if think of it like a bell curve and we would call like a size 48 or a half pound piece would be right in the middle. Ideally what we want is the tree to produce 40%, maybe more fruit that's in that size range and then fall off to each side of it and that's not what we saw this year on our harvesting and I think it got worse as the season moved on. certainly the fruit was sizing up, but as we harvested from some of our farms that were closer to the coast, which come later in the season, that's where we saw this larger size curve and it inhibited our ability to kind of move that fruit into some of the predetermined programs that we had set up earlier in the year. So I think we had a lot more fruit at the end later in the season that we had to move through kind of the broader market as opposed to our contractual pricing. Well, the thing that got magnified there too is with larger fruits ended up with more boxes and more loads and we didn't want -- we just kind of stretch the season out because we didn't want to put a bubble in there -- in the hose there and that kind of backfired on us with Mexico coming on hot with cheap fruit. And that was more -- the sizing thing is more weather related, right. That's what, the weather conditions were like optimal to grow giant fruit. Historically fruit can get pretty warm in their summertime, which is our wintertime and the trees go dormant and last year it was cool and they never went dormant. They grew the whole time and by the time we tried to slow the inputs down, i.e. fertilizer and water, it was too late too late. Got it. Okay, one last question for me is just I think in the press release, you talk about volume in Mexico being lower or so. I guess supply, is that just simply our growers holding avocados because the prices are too low. Is that the simple explanation for that? Well, there's fighting for size. Their size curve presently is pretty small. So they're kind of dragging their feet a little bit, but at the same time the demand is -- this is the slowest time of year between around Thanksgiving to Christmas and usually by right after Christmas it picks up for New Year's and then super bowl is after that and it just keeps rolling after that. So this isn't really a surprise. It just -- we're ready to go. We expect a bigger crop for the season as a whole. It may not come off linear. It may not be linear in terms of up 20% all for every month during the season. I think it the growth rates lagging a little bit behind that right now, but with the crop is there. In Mexico, in their defense they're probably not in a hurry because the prices are relatively low and they're waiting for better. Ladies and gentlemen, at this time, there are no further questions. I'd like to end the question-and-answer session and turn the conference call back over to management for any closing remarks. Well, thank you for your interest in Mission Produce and we look forward to speaking to all of you again soon. Thank you.
EarningCall_1496
Good afternoon. My name is Patrick, and I will be your operator today. Welcome to CN's Fourth Quarter and Full Year 2022 Financial and Operating Results Conference Call. After the speaker's remarks, there will be a question-and-answer session. [Operator Instructions]. I would now like to turn the call over to Paul Butcher, Vice President, Investor Relations. Ladies and gentlemen, Mr. Butcher. Well, thank you, Patrick. Good afternoon, everyone, and thank you for joining us for CN's Fourth Quarter and Full Year 2022 Financial results Conference Call. Before we begin, I'd like to draw your attention to the forward-looking statements and additional legal information available at the beginning of the presentation. As a reminder, today's conference call contains certain projections and other forward-looking statements within the meaning of the U.S. and Canadian securities laws. These statements are subject to risks and uncertainties that may cause actual results to differ materially from those expressed or implied in these statements and are more fully described in our cautionary statement regarding forward-looking statements in our presentation. After the prepared remarks, we will conduct a Q&A session. I do want to remind you to please limit yourself to 1 question. The IR team will be available after the call for any follow-up questions. Joining us on the call today are Tracy Robinson, our President and CEO; and Doug MacDonald, our Chief Marketing Officer; Ghislain Houle, our Chief Financial Officer; and last but not least, the youngest recruit on the team, Ed Harris, our Chief Operating Officer. Thanks, Paul, and welcome to our earnings call. I'm very pleased, whether you're with us by phone or webcast. We appreciate you joining us. Now I'm approaching -- getting close to the end of my first year with CN. And as I do that, I can't be prouder of this team and what we've accomplished together over the last year, it's important to me and to all of us that we've delivered on what we promised. We drove top line growth and we drove it to the bottom line. We started with a pretty tough first quarter, but we finished the year on guidance with an EPS up 25% and an operating ratio that starts with the 5 first since 2017. We also delivered a return on invested capital of 15.9% and free cash flow of nearly $4.3 billion. I want to take this opportunity to thank each of our CN employees. I am grateful for your focus and your hard work and delivering to some very big commitments this year. We came together as a team and across the entire organization, we have risen to the challenge. But we're not done. We've got more work to do on many fronts, and we'll be focusing on this through 2023. Without a doubt, we are in an uncertain economic time. And like many others, we are assuming this year, a mild recession. Now our bulk segment will help us in the first half of the year but we have less visibility in the second half. In this company, like others, we've dealt with recessions in the past, and we'll deal with this one. We have a great network and a diverse book of business provides stability for us in times like this. So we're going to remain nimble and close to our customers and will perform well this year regardless of volumes, and we will position ourselves for the upswing when it comes. And while current expectations that North American industrial production will be negative in 2023, we will grow EPS in the low single-digit range. Now the team with me today will walk through our performance 2022 and our outlook for 2023. I am pleased to have Ed Harris joining us on the call today for the first time. Ed was appointed Chief Operating Officer in December. And he brings a little bit of experience, 40 years of experience to our team. Most of that was with the CN running a scheduled operation. He's pretty passionate about being back and doing just that. Ed will give us an update on our operating performance, and he'll make some comments on our path forward on continuing to improve our operations and importantly, on his mandate to get the next generation of operating talent ready. Following a strong top line performance in 2022, Doug and his team are working closely with our customers to monitor volume trends and making sure our portfolio continues to fit our network. We're going to maintain our approach of selling into our capacity. Doug today will give you an update on our key markets and how we'll look to outperform that North American industrial production this year in terms of volumes. And Ghislain, as always, will cover the details of our financial performance in the quarter and the year as well as assumptions driving our 2023 financial outlook. Thank you, Tracy. Despite what Paul said, Tracy and I do go back a long way, when we both work for our Canadian competitor. And I can't tell you how happy I am to be back home where I dedicated a big part of my career. Ghislain, Doug, and I also go back a few years from my prior days at CN. Very happy to reconnect with them and also many others at CN. Some of which are the sons and daughters of the people I worked with a few years back. I reached out to Doug early on to better understand some of the challenges that we faced. And we have been working closely -- very closely sense to continue to improve our customer service. I love this business, and I feel energized about taking scheduled railroading to the next level. But more importantly, I'm here to help identify and mentor our talent and develop the next generation of railroaders. I can say that we have one of the best networks in the industry and a darn good team of operating people to maximize the efficiency of this network and enable growth for the North American economy. I came on board in April as a consultant and was very excited about the idea of helping this company refocus on scheduled railroading. You have seen the significant improvements throughout the year. I was convinced that this team had the muscle memory to get us back to where we used to be, and I want to thank all the operating people for their efforts. I have spent a considerable amount of time with the operating team since April. I've been out on the property quite a lot, and let me tell you that the talent is deeper than I initially thought. They are passionate and as a team, they want to drive more efficiencies going forward. While as a consultant, my role was more about suggesting ideas and making recommendations like starting on time and controlling train lengths and getting back to the 3 regions from the 2 that existed. Now as Chief Operating Officer, I can direct and have a more influential role in working with the team to implement some of the changes that will take this company to the next level. I am here to help the company. I want to be fast and quick, but before anything, I want to be safe. We have made great strides when it comes to safety performance. and we are now 748 days without a fatality and 560 days without a serious injury. Every day, we are beating a record. Railroading needs to remain simple. I think we got away from that over the past few years. Velocity creates capacity, the faster we are, the more we can handle. And the more we stick to the plan, the more reliable we are, which means that I could provide a level of service that Doug can sell to his customers. I've heard Tracy say so many times about how we're working on a more integrated basis. A big part of my philosophy is to work together as a team and work closely with the other functions. Collaboration is key and that's how we will move forward together. I could talk about railroading for hours, but now let me speak about a few of the operating highlights of the fourth quarter and some of my priorities for 2023. We continue to make good headway in terms of operating performance, though not without some challenges in the quarter. Car velocity averaged 207 miles per day in the fourth quarter, up 10% from last year, while origin train performance averaged 85% in quarter 4, also up 10% from last year. What I'm most proud of in the fourth quarter is how the operating team responded to the challenges and restore fluidity on the network following a period of extreme winter conditions in Western Canada in late December, with temperatures in some areas, dropping to a minus 50 Celsius for that time frame. Our approach to scheduled railroading and focus of our employees helped us to restore fluidity on the network. I am amazed how the team responded and you can see it in the operating performance. So far this month alone, car velocity is hovering near 220 car miles per day, similar to the numbers that this company saw last summer. Now winter is far from over, but compared to last year, we are in a much better position to start the year, and it means we should be in a better position to come out of winter into the spring. We are building resiliency based on running a scheduled operating plan with focus on service, asset utilization and velocity. Those terms should be familiar to all of you. Before I pass it on to Doug, let me provide you with some of my priorities for 2023. We're going to take scheduled railroading to the next level. There's more yet to be done here with a focus on destination and train performance and individual trip plans. We continue to drive capital efficiencies and we will deploy capital on the network engineering is already equipped and ready to get started on this year's program, starting naturally on our [indiscernible]. The mechanical team is bolstering in modernizing our fleet of locomotives with camera technology and energy management systems, which will help us be more efficient with fuel and safer. And finally, and perhaps most importantly, we are going to continue to coach and develop the next generations of railroaders. Thank you, Ed, and a huge thanks to you and your team from both me and our customers on the speed of our operating recovery after the extreme winter temperatures on our network in December. The team's disciplined execution and focus on velocity has delivered the service our customers need, and we are pleased that January is off to such a strong start. I'll now turn to Slide 9 and provide a review of our solid fourth quarter top line performance. Fourth quarter revenues were $4.5 billion, up 21% over Q4 of last year on 6% higher RTMs. Our bulk segments led the charge this quarter with strong year-over-year volume growth. We continue to achieve rail inflation plus pricing on renewals and the lower Canadian dollar also contributed to our revenue growth in the quarter. As expected, Canadian grain was very strong this quarter, including an all-time single-month record for tons shipped in October. We also saw growth in U.S. grain given the supply chain shift with the low water levels on the Mississippi River through the fall. For the full year, unit train shipments of U.S. grain to the Gulf beat the previous record from 2006. Coal demand remained strong through the fourth quarter with a strong commodity pricing environment. In fact, we set a record for coal shipment in 2022 with over 30 million tons shipped for the full year. Automotive volumes were strong in the quarter as inventory replenishment continued across the industry. We did, however, see some weakness expand in other segments in the fourth quarter. A softening in international intermodal as volumes tapered through all gateways due to inventory overstocking. Lower petroleum and chemicals volumes with reductions in refined products as well as lower chemicals and plastics used as inputs into manufacturing due to numerous small outages and a softer market demand. Lumber and panels decreased following additional mill curtailments in British Columbia due to low commodity prices, high stumpage fees in BC and lower housing demand due to rising interest rates. Before I review our market outlook for 2023, let me provide you with updates on some of the initiatives we spoke about earlier this year. Despite some recent softness, the Port of Halifax had a record volume year for intermodal in 2022, handling in excess of 600,000 TEUs and CN and our partners, PSA and Port of Halifax are all working with our customers to grow the terminal in 2023 and look forward to selling out the terminal in years to come. On the EMP program, which is a shared intermodal equipment pool with the UP and NS, CN has now fully integrated the program into our operations and sales. CN will be adding containers to this pool over the next 2 years as we continue to grow the business for the interline domestic intermodal. CN finished off 2022 averaging over $1 million per week in new business. The Canadian West Coast export propane program continued to gain momentum in 2022. Working with our partners in Prince Rupert, CN moved over 10,000 cars this quarter to terminals in Prince Rupert to support Canada's growing energy export market, an increase of 17% over Q4 2021. We expect this program to continue to grow as additional drilling and gas processing takes place in advance of the new LNG plant coming online in 2025. Finally, turning to Slide 10. We are assuming a mild recession as our base case. We have good visibility in H1 as we continue to move significantly higher Canadian grain crop. With the current economic environment, the H2 outlook remains uncertain at this point. On the bulk side, we expect continued strength in 2023. We will be moving last fall's Canadian grain crop well into 2023, and we are anticipating an average crop for the 2023, 2024 crop year. We expect coal demand to... All participants continue to stand by. The lines for the moderators have disconnected. Once again, please continue to stand by. We are back in the call. Please go ahead. Thank you, everyone. I think we got cut off there, so I'll just continue with my remarks. So we expect coal demand to remain strong through 2023 with commodity pricing staying favorable. Energy shortages are keeping demand strong, and the backlog in autos and development in Asia will underpin net coal demand. We expect more of a flat to negative performance with most other commodities. The weakness that we began seeing in the fourth quarter is expected to persist through at least the first half of 2023. The international intermodal will have multiple blank sailings as the North American inventories rebalance. Lumber will be slow to recover due to market oversupply and high interest rates dampening demand. Chemical and petroleum production is directly tied to the economy, so we expect demand to be soft in the first half of 2023. Automobiles are still in a tight supply situation, but this is changing with higher interest rates as well as part shortages. To close, we are working closely with customers to monitor the economic environment as we run a scheduled railroad with a focus on velocity, we are achieving solid performance that will serve our customers well and continue to grow with our customers as the economy recovers. Thanks, Doug, and welcome, Ed, it nice that you're back home. It's my pleasure to review our excellent fourth quarter and full year financial results. I will talk to Slide 12 of the presentation, which will provide more visibility on our fourth quarter performance. These results highlight the strength and resilience of our franchise as we delivered volume growth of 6% in terms of RTMs and 21% growth in revenues despite some significant weather challenges in December. The top line performance, combined with the strong operating performance, grew solid earnings in the quarter. Let me provide you with more details on the quarter, and I will speak to the adjusted numbers, which exclude advisory costs related to shareholder matters in the fourth quarter of 2021. Labor expense was up around $40 million in the quarter versus last year, driven by increased wages due to higher average head count of close to 900 transportation employees versus last year. Our fuel expense was up nearly 50% FX adjusted, as fuel prices were over 45% higher in the quarter versus Q4 of 2021 and volumes contributed to the remaining 5%. We delivered operating income of $1.9 billion in Q4, up 21% on an adjusted basis. Our operating ratio came in at 57.9%, which is in line with the adjusted operating ratio for the same period last year. Diluted EPS of $2.10 for the quarter was up 23% versus last year on an adjusted basis. Turning to our full year results on Slide 13. I am very proud of our adjusted EPS growth of 25% versus last year, which is aligned with our guidance, demonstrating the strength and resiliency of our franchise and validates the effectiveness of operating a scheduled railroad with a focus on car velocity and working on an integrated basis. We generated free cash flow of nearly $4.3 billion for the year, exceeding our guidance. Under our current share repurchase program, which runs from February 1, 2022, through January 31, 2023, we have repurchased over 29 million shares for $4.6 billion at the end of December. Finally, at the end of 2022, our return on invested capital finished at close to 16%, exceeding our 15% guidance. Moving on to Slide 14. Let me provide some visibility to 2023. As we continue to see weakness in certain segments like international intermodal, driven by lower consumer spending, lumber, chemicals and plastics, we also see weakening economic indicators with negative North American industrial production expected in 2023. Therefore, like many others, we are assuming a mild recession in 2023 with some rebound in 2024. We have good visibility on Canadian grain for the first half of 2023 and currently assume an average crop starting in the second half of the year. As Ed mentioned, we are off to a good start in January from an operating perspective, and Doug and his team remain disciplined on pricing, but we will be facing some headwinds on the Canadian labor front in regards to work/rest rules and paid sick days. Despite a weakening economic environment, we expect to deliver low single-digit EPS growth in 2023 versus 2022. In terms of shareholder distribution, we are pleased to announce that our Board of Directors approved an 8% dividend increase for 2023. This represents the 27th consecutive year of dividend increase since the 1995 IPO and reflects both the confidence in our strong cash flow generation capacity throughout business cycles and the long-term prospects for the company. The Board also approved a new share buyback program of up to 32 million shares for an amount in the range of $4 billion to be returned to shareholders through a normal course issuer bid from February 1, 2023 to January 31, 2024. In conclusion, let me reiterate a few points. We delivered a strong fourth quarter performance as we continue to push on operating a scheduled railroad. We met our 2022 financial guidance. We are witnessing continuing economic weakness and calling for a mild recession in 2023. Despite this weak economic environment, we are still guiding for EPS growth, demonstrating the resilience of our franchise and the strength of our team. We have a strong balance sheet that provides us financial flexibility, and we will allocate our capital in a manner that drives long-term value for our shareholders. Thank you, Ghislain. So today has been a good opportunity to look back at a number of our successes in 2022, and I'm really proud of what we've accomplished together. But this team and I are looking ahead to the future to where we want to take our company and it will take a continued focus on performing at an ever higher level across the organization. As Ed said so, it's not that complicated. We're going to keep it simple. It starts with the plan. We're focusing on the next level of operating performance through the scheduled operating plan and further integrating our team across functions. We're continuing to get closer to our customers, earning their trust through great service and partnering in their growth, and we're going to leverage the strength of our network to grow with them in a manner that's good for both of us. We're in the longest stretch of our company's history without a fatality or serious injury, and there's nothing more important to us than this. But it doesn't mean that we get complacent. That means we get even more committed to our safety culture and looking out for each other every day. We know now what's possible. Our efforts on climate and sustainability are advancing. A number of organizations last year recognized our sustainability efforts. We made the CDPA list once again, and we've now been listed for the 11th consecutive year on the Dow Jones Sustainability World Index. We appreciate the recognition, but we're really focused on is to continue to pursue this agenda, which amongst other objectives is going to help us further improve our industry-leading fuel efficiency. And last but not least, of course, we're intently focused on developing the next generation of talent at CN. There's tremendous capability in this company, as you've seen. And we have the senior team in place now to bring them and their performance up to the next level. You're going to hear a lot more details about our vision and our growth plan and our performance at our Investor Day in Chicago in early May, and we're looking forward to seeing you all there. Maybe I wanted to start on the guidance and I appreciate the fact that you're being, I think, cautious about the outlook or may be realistic about the outlook for a recession in 2023. Ghislain or Tracy, maybe you could walk us through some of the underlying dynamics of that outlook. How do you think about RTMs and maybe how do those progress over the course of the year? And then if we can get revenue growth in the year, do you think operating ratio improvement is possible as well to get you to that low single-digit EPS growth. Chris, that is the question, isn't it. We're giving you today our guidance based on what is the best information we have right now. Given the uncertainty in the economy and what may happen this year, I think it's the right amount of information to provide. We do hope that it will be better than what we expect. And we'll be ready if that happens. And as we get more clarity, we'll be in front of you with updates. But I think we'll keep it pretty much at that level for today. We think that -- I'm going to hand it over to Ghis to comment, but we do believe that we can lift our volumes higher than the industrial production, as Ghislain said in his note. Just wanted to follow up on previous question actually. If we look at the EPS guidance for low single digit, we also have a share repurchase here, which could potentially be in the low single-digit range. And then volume, as you said, it's above IP pricing of inflation. Is there something on the yield or operating ratio that we need to figure out to kind of account for the gap? Is it the mix? Is it the accessorial charges? Something else that you're missing. Well, thanks, Konark, listen, as we just said, I think that we're assuming right now the industrial production in North America will be negative. As Tracy just mentioned, we're assuming that we'll do a little bit better than that. We will continue to work on our margins. I mean, we know that we need to improve our margins on a year-over-year basis. However, as you know, it's tougher to improve margins when you're in a low volume environment. But we're very confident over the mid to long term that there's no question that we will improve our margins. When you look at what we've done in 2022, I mean, our incremental margins for the full year was a respectable 50%, and we improved ROR by 130 basis points. So that sets the stage. And with the scheduled railroading back in full force, I think that it's all going to depend on volumes and it's all going to depend on the economic environment. I mean if economic environment does a little bit better, then we'll ride the way. If it's deeper than what we think, then -- and it's not mild, but it's deeper, then we'll perform. I mean, we're well positioned to perform in a recession, and we have a strong balance sheet. So I think we're -- and as -- and I'll finish on this, Ed mentioned it, but we're starting January quite well with the weather collaborating. So our volumes are good. But remember that we are comping versus last year where we were in deep freeze. So -- and we can count our chicken too early. We just have about 21 days behind us. I wanted to ask a bit about how you think about pricing against this backdrop of weaker cyclical backdrop. I think the commentary from the Canadian rails in 2022 was pretty optimistic, tight capacity, pretty favorable trends in pricing. Would we expect that to ease meaningfully against weaker volume backdrop? Or you think there's some momentum that carries through that you still have a maybe stronger than normal pricing in 2023? Thanks, Tom. It's Doug. So once again, I'll say we have -- about 1/3 of our book of business comes up every year for repricing. So we do -- we have seen a strong pricing environment continue. We do have some catch-up to do from prior years. And our goal continues to be pricing above rail inflation. And we really don't see any issues with that at all so far. So can you kind of comment on pricing this year versus last year? Do you think it's similar or a bit lighter given the volume backdrop? It's very similar right now. We expect a pricing overall for -- or costing for overall for the rail industry. We expect to stay ahead of that. So right now, it's showing very high when you look at the all-inclusive index and things like that, and we continue to be above that. I just wanted to ask, Ghislain, you mentioned some headwinds on Work/Rest Rules and paid sick days. I wanted to see if you could elaborate on that is that the federally mandated one that kicked in at the end of last year? And how is that going to impact the financials or headcount? And how should we expect that to kind of roll out throughout the year? Yes. Thanks, Brian. Yes, definitely some headwinds there. Ed and the team will work hard to try to minimize the unfavorable potential impact of those headwinds. But I'd say that when you put them together, they could be as much as $100 million of headwind in 2023. So we'll see, but that's certainly something we have to deal with. That's the notion. The notion is that you would have to have more people to do the same amount of work, and therefore, it does create a financial unfavorable impact. But as I said, Ed will -- and the team are working to try to minimize the impact. But -- so we're all over this as we speak. Brian, if I could just add, it's Ed Harris. We're looking at the operating plan very closely, and we look at it every day, which is no secret to anyone. I think the things that you have to remember with a stronger operating plan and better system performance, we're taking out a lot of unnecessary operating expense like recrewing trains, the die and route or deadheading to a better schedule. And there's quite a bit of savings that we'll see through that as we get stronger in our operating plan. So that's one of the ways that we're thinking about offsetting some of the headwinds. We talk about this quite a bit, and we got a pretty good plan we're working on. Yes. And welcome back, Ed, to CN. Obviously, a lot has been accomplished since April, but could you provide more color about some changes that you're looking to implement that would bring the company to the next level? And maybe if you could expand a bit on the headcount for 2023 and CapEx envelope in order to drive the operations. Well, I think one of the first things that I saw while I was consulting beginning in April was there wasn't much adherence to an operating plan and the discipline that we put in beginning in April started leading into some savings right off the bat. And it was something as simple, Benoit, is running on time. From that, we looked at train length. We were running trains way too long, way out of slot, which just created a lot of havoc across the network and really killed our service offering. So we got trains back where they need to be. And lo and behold, our velocity jumps up significantly, probably, what, 10% or so looking at the team here, made all the difference in the world of getting across the railroad. So that's the basis of the operating plan as we speak right now. Train speed has come up very nicely. I've already mentioned about the progress we've made in a necessary expense behind dead heading and recrewing, tighter schedule adherence, and this is near and dear to my heart. We stay with the schedule 7 days a week, and we run the same schedule every day. And if the traffic is there, we're going. If the traffic is not there, we're going, whether it's 120 cars or 40 cars, we're leaving on time. That's really the secret of the business, right? The way I was brought up, and that's what we've been doing. We're also going to reinstitute individual car trip plans. This is something that we started back in the early 2000s. You probably remember it, where we can actually see where the car falls off trip plan, we can isolate the location where it fell off trip plan, the reason why it fell off trip plan, and it was a daily correction exercise we went through. Very impressive to a customer that wants to know why their car is not on time, and we can roll out exactly why it wasn't on time and the reason for it when Doug sales force makes a call. So that's just some of the plan that we've been addressing since I've been on board, and it's a lot easier to do it as an active employee than it as a consultant. I don't like suggesting anything. I like telling. So that's where we're at. And so far, so good. I'm very pleased with the results and the progress that we've made operationally. I also had a question for Ed. So I guess I'm picking up on the last one. First of all, welcome back. Just curious now that you returned to CN after having had the opportunity to assist out a couple of other class ones operationally. Can you comment on what you think RCM's particular strength from an operating perspective? And I think in your prepared remarks, you mentioned the company is moving back to 3 operating regions from 2. So maybe within that, you could outline the rationale for that in particular? Well, I don't like to compare ourselves to other carriers because all the networks are different to begin with. And I can tell you, I learned a lot in my time with other carriers. I learned different ways of doing the business. But quite frankly, as I said earlier, this is a simple process. I mean Mr. Harrison always just tell us it's like checkers, keep them on the black squares and figure out that way around them. And that's exactly what we're doing here today. What I'm very pleased about this network is it's solid. It's linear, it's easy to operate on, and it's pretty easy to schedule when it comes right down to it. There's not a lot of interference with cross traffic or other railroads and the acquisition, when I left CN to begin with, I wish I was part of it, the EJ&E acquisition, we fly through Chicago. I mean, instead of taking 12 hours to get through the city, to get to our yards on the south end, where we rounded in an hour. That benefit is unbelievable. And the ability to run trains out of Winnipeg through the J to Toronto around the South Lake, Michigan, is just fantastic. I mean I wish I could have been here when they bought it because I would have been on the first train going around the horn. But actually, a lot of opportunity, a lot of possibilities here. And I've just started digging back in really when it comes right down to it. I am extremely impressed with the management team here, the operators, lot of knowledge, a lot of people that were here before. A lot of people that came from other carriers that understand the game, too. So besides that, and we simplified the network going from 2 regions, which to me was just too much for any 1 guy to handle to 3 regions. I like my operating officers to be able to be in the face and talk to the crews and be part of the crew solutions. And this allows them to do that. And we set up the organization. We just finished reorganizing the operating department and a traditional realm that we used to do back in the days. In fact, Ghislain said, "Hell, that's the way we used to do it when was here." And that was the truth. We did it the same way again because that's what I was familiar with, and it leads into what's down the road for the next generation of railroads. You can see it on the org chart. if you're second or third out, you can plan on getting promoted probably in about 5 to 10 years. And that's the way I want these people thinking. And I think that drives efficiencies and opportunities. So I hope that answered your question. I probably got a little long winded, but like I say, I like railroading. And Ed, welcome back. Ghislain, I hate to focus on the operating ratio. But I guess given the EPS guide, it seems like there's some pushes and pulls here on the outlook for margins. So -- is this an environment where you think some of those cost pressures might be too much to show a lot of improvement this year? No. Listen, Brandon, as I said before, we are continuing to focus on costs. We know we need to improve our margins on a year-over-year basis. And it's just -- we have a low volume environment, so it makes it a little bit challenging, but we are working on it and stay tuned. I think we'll see what happens, and we'll see what happens with the economy. Let me come in over top of that just for a moment, Brandon. So I'm pretty proud of what this team did this year on a 130 basis points improvement. When you want to improve operating ratio and improving our margins, it takes everybody. It means a good efficient operation. It means that you sell into your network, and it means you price properly and you stay focused on the velocity of your operations. So those are all basic building blocks. And in any economic environment this year, whatever unfolds, those are the things that we're going to be working on. We have a couple of headwinds that Ghislain outlined to you. We'll see how those play out over the year. We're going to mitigate them as much as we can. So really, it comes down to what kind of leverage we get out of volumes. And that remains to be seen. So we will be in front of you as that becomes more clear to us. Great. I'll echo Ed, welcome back. Great to talk to you again. Ghislain, I'm going to throw one to you, I guess, very similar to the [indiscernible] questions. But maybe talk about last year's first quarter, let's go near term. I know there's so much in the year ahead, you don't want to kind of guess too. But maybe talk about the weather impact that impacted first quarter last year because you had, I guess, you go about the last couple of years about a 500 basis points deterioration that's been normal in the first quarter. Should we not expect that, given it sounds like weather is a little bit better or anything different because of the operations just maybe going near term on that? And then just a quick follow-up. Did you say the plan and traffic changed? Or were people just not following the plan that existed? Just trying to understand what difference happened so quickly. Well, let me start with your first piece of the question and then we can turn it over to Ed. So yes, Ken, absolutely last year, at this time, we were in deep freeze. And you remember well, we finished Q1 with an OR that was 66.6%. So this year, when you look at our volumes, they're up and you see them on a weekly basis. The weather, we've been blessed with the weather across the network. So that's helped. The team is functioning very well. But as I said, don't -- let's not count our chickens too early. We have 20-some-odd days behind us. We'll see what happens. Winter is not all over, by the way, when I look at next week, it's supposed to be in the minus 20, 25 in some parts of the country. So what's in the bank is in the bank, we'll see. But definitely, we had good operating conditions so far. I would say that my comment about following the trip plan, it was just something as simple as you got a plan out there, why don't you run to it and run on time, depart on time. And that really is what pushed the envelope to getting people focused on following a scheduled railroad. That was the first step. And we're well into it now. So... A follow-up on the volume commentary for '23. Tracy, I think you said at the top of the call that you think the first half is going to be fine, but the second half visibility is low I think there is at least one scenario that believes that in the back half of the year, kind of inflation should be more under control and kind of rates are potentially under control and inventories are potentially under control. And so the back half outlook should be better in the first half outlook. Can you talk about kind of why you think there's less visibility into the second half and maybe some of the kind of things that concern you about volumes right now? Ravi, what I said was that we have a clear line of sight in the first half, given we know what the grain crop is. And as Doug outlined, we know what coal looks like. And Doug outlined kind of where we see the softness. What I said about the second half is we don't have line of sight. We've modeled a certain grain crop, but the crop is not in the ground yet. So it remains to be seen what that looks like. And we are hearing, like you, any number of different scenarios on what inflation may do and therefore, how quickly volumes may rebound. As I said, our guidance is based on the best information that we have right now. And as we get further into the year, we'll give you an update as it becomes clear. It's the -- we are assuming that we will do the entire program. So we're assuming -- I mean, we're finishing at the end of January, the $5 billion share buyback program, and we're assuming that we will do the entire program, the $4 billion, we're assuming we'll do that up until the end of January of 2024. Yes. And, Ed, nice to have you back on this call. I hate to make you endure one more question on guidance. But I hear you talking about how operationally things should continue to improve this year and pricing ahead of inflation and you've got the share count going down in the 3%, 4% on average this year potentially. Just how bad do you think the volume could be this year? Just seems to be kind of the variable that may be keeping you on the edge a little bit with the guidance. Are there kind of specific end market you're worried about? Are there other cost items that outside of the labor that maybe just last are factored in this guidance that you may be missing? Thanks, Fadi. Let me take a start at that one. We think it's prudent given the uncertainty of the volume environment, the economic environment to be a little bit cautious here. As we said, North American the production -- industrial production slightly negative. We believe on volumes, we're going to do more than that. We've got the next schedule. We've got all the building blocks that we'll continue to work on the next step up on the scheduled railroading, a little bit more velocity. Doug, on the 1/3 that's opening up is going to go after pricing ahead of inflation. As Ghislain said, we've got some headwinds on the labor side that we're working through. We hope to be able to mitigate. But we think it's prudent given where we are in the year, to be a little bit cautious here. So that's where we're sitting at this point. We recognize that as the year unfolds, this could be more optimistic or even, I guess, there's a scenario where it's more pessimistic. This is where we're sitting right now. So obviously, we're all trying to figure out like how much of this is macro uncertainty, conservatism versus reality. So maybe Ghislain, like you talked about the $100 million headwind from the paid sick and work rules. Anything else just you want us to be considering. Is pension a headwind? I know fuel was a big tailwind last year. Does that turn into a headwind this year? Anything else that you just want us to be thinking about? And then I didn't hear a CapEx number. I don't know if I missed it, but if not, can you just share CapEx for the year? Yes. So yes, the big ticket items, obviously, is what I mentioned in terms of the labor headwind. In terms of pension, we don't see a big headwind on pension. I think we see even a little bit of a tailwind next year. And I think on CapEx, I think that we did not talk a lot about CapEx. I think you can assume that we would continue to invest in the range, high level of the last few years. And those are the big ticket items. I think that when you look at fuel, it could be a bit of a headwind in terms of fuel surcharge. When you look at our average OHD last year, is -- it was around $480. And I think that the spot rate on OHD so far is about $450. So if you assume that the $450 million remains, then that could be a bit of a in terms of fuel surcharge for 2023. But I would say that these are essentially the big ticket items. It's great to have you back on the call. And just on that, Ed, you mentioned grooming the next generation of railroaders and certainly creating a -- or recreating a culture of precision scheduled railroading is not easy. It takes some time. Curious how you're going to approach that? How long do you think it will take? Are you going to -- is it all going to be homegrown or are you going to look to outside talent? Just curious to hear your overall strategy in terms of that task of groom in the next-generation railroaders. Well, thanks for the question. We've already started. We've got 3 or 4 candidates that we're looking at very closely. We're changing duties for each of the candidates as the year goes on to get them prepared to handle more than what the responsibilities are today. I don't think -- we're going to look to the outside unless Tracy's got plans I'm not aware of, but I like this team. I like everything I've seen about it since I came back full time and very confident in the level of expertise and operational knowledge that's out there. So no, I'm not looking on the outside. And yes, we already got candidates we're considering right now. I wanted to follow up on that fuel question and discussion. One of the things we've noticed, obviously, is when you look at fuel surcharge revenue over the last several quarters and the coverage of that revenue relative to the expense is just much higher than it has been really at any time in the past. And I want to understand kind of, has there been a change in like the fuel mechanism or something that allows that fuel surcharge revenue to kind of well more than cover the expense? And can that unwind and could that be a source of kind of profit headwind just really based on like how that ratio has trended today versus how it trends over the last many years? Amit, when you look at fuel, last year, you're right. I mean it had a lot of noise on a quarter-to-quarter basis due to the fuel lag. I mean if you look at last -- Q1 last year, I mean, our fuel lag was negative by $0.13 on a year-over-year basis in terms of EPS. So you've had a lot of noise on fuel lag. And also, if you look at it, as you know, the fuel surcharge is really based on OHD and whereas our fuel expense is based on fuel spot prices, and there was a certain disconnect last year between the OHD and WTI that created some of that noise. But I would leave it at that. That's pretty much it. Thank you. Good afternoon. Doug, I wanted to ask you about capacity. I mean you're dealing with a lot of moving parts here, really strong grain, kind of uncertainty in international intermodal, weak industrial. At the same time, you're implementing somewhat of a new operating plan. How are you managing your capacity across the entire network with so many moving parts to ensure that you don't have an elevated cost basis, but also to ensure you still have the capacity if growth does pick up before you expect it to? Well, it's a great question, Jon. So it's really a team sport, right? So we work hand-in-hand with Ed and his team. We're really sitting [indiscernible] segment by segment, we kind of detailed out what exactly are our capacity along each lane. We actually assign our traffic, our scheduled traffic to it. So -- and Ed's team moves it in that lane. So as we continue to look at and change, we add in more traffic where we take out more traffic and we make sure that the network can handle it. So as we're out selling from a sales perspective, we actually come out and we price to that capacity and we try and fill out those trains. Ed's team does a great job at moving it. So -- and they let us know here, you've got some areas to sell in, so we go do it. And it's worked out really well, and we're going to continue to grow our railway based on the capacity that we have and we expand to. So just on this legislation just came about in December. I guess I'm wondering how fixed and firm it is and whether there might be an opportunity to work with the regulators to try and engineer a solution that adds the time off, but in a structured way that limits the productivity drag of having just to add excess resources to deal with increased callouts and things like that? David, it's Tracy. I'll take that one. I think that the right form to work that out is sitting in front of our employees and their representatives. And so we have discussions and we'll be in negotiations this year with a number of them, and we look forward to that opportunity to work out what an agreement on what works for them and what works for us, and we think that we're going to find something that's in between. Yes. I mean I appreciate you don't want to negotiate on the call here. But I mean, historically, CN has had a pretty good track record of kind of working with labor to find ways that align interests as opposed to the disruptive things like this. I'm just wondering like the $100 million estimate, like how firm is that? I mean, I got to imagine it's a plug at this point? You know it is. It's a rough estimate based on a number of assumptions. So we are in negotiations, as you said, right now, with a few of our unions. We've had -- we've got a new agreement in place with the IBEW. We've got a new agreement in place with the RTCs. Both of them are multiyear agreements. We're in negotiations with others. And we hope to reach settlements, as you say, the way we have in the past to protect our workers and they protect our efficiency and agreements that work for both of us. So certainly, that's the perspective that we're going into this with. And it's one of those things that will give you a little bit more visibility on as we get into it over the course of the year. But it's prudent to raise it as a variable issue. Just hoping you could perhaps provide some commentary around the intermodal outlook and specifically, the delta you're seeing between international and domestic. I think on the last call, you had started to acknowledge some weakness in the international side, and that continues to be the case. But domestic weakness is a newer phenomenon that's been downgraded it seems. Just maybe some commentary around the relative prospects for the 2 would be helpful for the year. Thanks, Steve. It's Doug. So it's a good question. So on the international side, we continue to see some inventory overstocking. We continue to see blank sailings coming in from Asia. There's some forecast for that to continue all the way through the first quarter. So we do see weakness there, but we don't have a lot of visibility moving forward. On the domestic side, we're actually seeing some very normal volumes right now. We're not seeing a lot of weakness, but we're not seeing a lot of strength. So what we're doing is being -- we're doing fairly conservative around volumes. We think we're set up to move at all. And the customers are, I think, right now that even though with dropping truck prices, we're still being very steady from the rail standpoint. So I wanted to ask, in terms of the volume outlook and maybe some of the conservatism around that, does any of that reflect anticipated impact from the CP KCS merger going through? And then separately, with regard to this Investor Day coming up, in May. I just wanted to understand, Tracy, kind of what are your objectives there? And what are the main things that you're trying to communicate to investors that you feel maybe aren't being understood? Or I guess why holding Investor Day now? Thanks for the question. Firstly, the KCS, I mean, we've talked about this a number of times. We're very comfortable with our position relative to any announcement or any merger that may take place there. We're pretty focused on our own game. And when we're on our game, and we're pretty tough to beat. So what we'll do at Investor Day is lay out for you a couple of things that we think are important to have a dialogue with you about. And one of them is where we see the scheduled operation taking us in the future. And the resilience of that is the basis for all of what we're going to talk to you in the first -- in the future is really the core of how we run this railroad. And when I say scheduled operation, I mean not just the operations side of it, but it's how we sell into the capacity as well. The second thing we'll talk to you, we'll lay out for you is how we see the growth shaping up as we look forward. We're pretty excited about some of the growth prospects. This year is an anomaly. We've got a little bit of a turndown. This has happened before. It will happen again. But we'll come out of this very nicely. I think we're very well positioned. But what we'll be talking to you about in May and Chicago is how we see the growth over the medium term to the longer term. And there's a lot there that we're excited to talk to you about. Tracy, when you were brought on board, one of the themes you talked about was curating the book of business. Is that process now complete? And if it is, is the next leg of OR improvement dependent on volume growth? Or do you still see what I would define as self-help opportunities that can drive meaningful margin improvement in the absence of volumes moving higher? So Justin, last year this time, we had a book of business that didn't fit our network and our capacity perfectly. And when you do that, it's very difficult to run the operation in such a way that you get efficient and fast and that you deliver the service to your customers that you promised them. So we needed to pick some of that up and all of that is behind us. The way that we look at the opportunities of scheduled railroad going forward, yes, year-over-year, you're going to see improvements in velocity. As Ed gets us completely organized around this. There's some more that we need to do, and he'll talk to you about that along with the team when we get to Investor Day. But the next path on this, the next step is really to sell into the capacity that we've unveiled as we've kind of advanced the scheduled plan then. So we can now see where we've got train capacity in corridors and where we have capacity on trains that aren't running yet to maximum length. So Doug gets the mandate to sell into the trains where we have capacity and to focus on selling into the existing capacity that we have on the railroad primarily right now in the East and the South. Beyond that, we're focused on where we can partner with our customers, organic growth, new markets, some of which we've talked about before, some of which we'll talk about to you in May, where we would invest for that growth. So I think it's -- those are the next 2 steps. Ed, welcome back. I wanted to piggyback on one of the questions about sort of the potential of CP KSC merger, if it gets approved, is the guidance assuming any concessions from that? Or would any concessions potentially add to your outlook? Listen, I -- interesting question. I think that our guidance assumes the work that we've done now to make sure that we've secured our business relative to any transaction that may take place. And it assumes the other volume and pricing estimates that you've seen there. So I think we'll leave that one at that and see what happens from here. Thanks for your interest today. We know it's a little bit of an uncertain climate and a certain year. We're pretty focused on doing our job well, running efficiently, and we will, we believe, lift our volumes above what the market would tell us industrial production is this year. And most importantly, we look forward to connecting with you again at the end of the first quarter, where inevitably, we'll have a little bit more information. Thanks for your time today. Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.
EarningCall_1497
Hello, and thank you for standing by for Energy Monster’s 2022 Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Today’s conference is being recorded. [Operator Instructions] I would now like to turn the meeting over to your host for today’s conference call, Director of Investor Relations, Hansen Shi. Thank you. Welcome to our 2022 third quarter earnings conference call. Joining me on the call today are Mars Cai, Energy Monster’s Chairman and Chief Executive Officer; and Maria Xin, Chief Financial Officer. For today's agenda, management will discuss business updates, operation highlights, and financial performance for the third quarter of 2022. Before we continue, I refer you to our Safe Harbor statement in the earnings press release, which applies to this call as we will make forward-looking statements. Also, this call includes discussion of certain non-GAAP financial measures. Please refer to our earnings release, which contains a reconciliation of non-GAAP measures to the most directly comparable GAAP measures. Finally, please note that unless otherwise stated, all figures mentioned during this conference call are in RMB. I would now like to turn the call over to our Chairman and Chief Executive Officer, Mars Cai for the business and operation highlights. Thank you, Hansen. Good day, everyone. Welcome to our 2022 third quarter earnings call. In the third quarter, the effects of COVID continues to impact our operation as quarantine and lockdown measures resulted in a general decline in offline foot traffic in a number of regions within China. We however, remain resilient against these challenges and committed to delivering value to all of our partners. We continue to transition our operations to better mitigate the impact from COVID-related reasons, namely through the increasing contribution of the network partner model and the decreasing usage of entry fees or upfront fees for new signings. Revenues for the third quarter was above our guidance as the recovery from COVID was above our previous expectation, and as we continue implementing measures to effectively expand the coverage of our mobile device charging operation despite the COVID headwinds. Our mobile device charging service network is as expensive as ever. As of the end of the third quarter, our network features 965,000 POI locations, 6.4 million power banks in circulation and 325 million registered users across 1,800 counties and county-leveled regions. The recovery during the third quarter was strong quarter-over-quarter with revenue increasing by 18%. Revenue per power bank increasing by 11% and adjusted net loss declining 50%. While the recovery trend is clear cut, the impact from COVID is also evident across various regions. In the third quarter of 2022, notable COVID outbreaks in Shiyan and Xiamen in mid-August. Chengdu and Shenzhen starting from late August resulted in 49%, 68%, 84%, and 50% week-over-week declines in revenue respectively. Recovery rate from the outbreaks is also more pronounced. Chengdu, Shiyan, Shenzhen and Xiamen bounced back to 94%, 82%, 85%, and 62% in the following week when COVID cases are fully contained. While those outbreaks have been less severe compared to the outbreaks in Shanghai and Beijing during the second quarter, the frequency of these outbreaks have increased during the third quarter and continues to weigh down our operational and financial performance. The headwind set forth by COVID continues to be the largest challenge to our operation on and off in the past three years. In recent weeks, there has been a clear trend towards the easing of COVID-related quarantine measures across the country. We believe this trend will be able to unlock the full recovery of the offline traffic and release the growth potential of the mobile device charging service here in China. While we are excited about the long-term outlook and general recovery of industry, we expect the impact from COVID to remain during the fourth quarter and going into early next year. That is why we remain committed to effectively increasing the coverage of our mobile device charging service network. On the coverage expansion side, our increased coverage through the combination of our direct and network partner models will help us further extend the Energy Monster network effect, which makes it easier for us to acquire users, location partners and network partners. This network effect continues to be a vital differentiating factor in our industry-leading growth as the industry is posed to for a recovery. On the efficiency side, our focus on lowering incentive fee rates for new signings with less usage of fixed incentive fees, reducing hardware CapEx per cabinet and increasing efficiencies of our employees continue to help us reach higher levels of efficiency. These initiatives in improving our efficiency will be especially apparent once the offline foot traffic fully normalized in China. The impact from COVID has challenged our operation in recent years, but now more than ever we are expecting a gradual recovery to full normalization. Our strategies in expanding our network coverage and improving our efficiency have developed into our competitive mode and will serve as the key drivers for our growth as the industry enters into an overall [recovery train]. Now let me go through our core strategies during the third quarter in terms of expanding our coverage and increasing our efficiency in greater details. First of all, it is the coverage, which continues to be primarily driven by our network partner model, POIs operated under the network partner continue its upward trajectory as of the end of the third quarter. POI is under the network partner model reached 47%, reaching a historical high compared to the 43% last quarter and 36% during the same period last year. The rapid growth in our network partner contribution is driven by the increase in our network partner count and the growing strategy synergy between our two models. We continued to acquire network partners at record speed. During the third quarter, a number of active network partner reached more than 5,300 a substantial increase from the approximate 3,000 during the second quarter of this year and 800 during the same period last year. This growth momentum in network partner is primarily filled through the combination of the program, allowing our direct model business development personnel to acquire network partners as well as the increase driven by network partners development team. The network partner program under the direct model initially launched in April this year and was designed to give our direct model team an alternative avenue to effectively increase Energy Monster’s coverage because our direct model business development personnel are locally based and have extensive relationships with local partners within their region of coverage, they also accumulate relationships with potential network partners as well. Notably, their understanding of the regional competitive landscape in conjunction with their ability to deploy either the direct or network partner model gives us the ability to more flexibly increase our market presence. This program continues to be widely popular amongst our direct model business development team and a key driver for our network coverage expansion. With the large influx of new network partners, our operational collaboration after launching the new partnership becomes all that more important. A number of these new network partners have existing expertise in other industry, but with limited experience in the mobile device charging service industry. That is why the important – it is important to help these new partners hit the ground running. To do so, we have dedicated teams of operational expertise that closely monitor the performance of each network partner. They constantly share the know-hows of industry that we have accumulated over the years to these network partners so that they can successfully manage their own teams. For more experienced network partners, we also provide advanced metrics such as local heat maps and competitive landscape analysis, so that they can scale their operation to new heights. During the quarter, we also launched more features for the network partners backend system so that they can more efficiently manage their POIs and teams. Our focus on providing post-engagement, consultation and operational tools for our network partners is the main differentiator for Energy Monster. Our commitment to these values helps our network partners achieve industry-leading returns and help Energy Monster effectively and constantly increase its market share in China's mobile device charging service industry. While the ability for our direct model team to also leverage the network partner model, greatly increase our expansion and the network partner model. Our direct model also continues to maintain its commitment to effective expansion. The impact of COVID has been challenged, especially for our direct model, given that outbreaks typically affect higher tier cities, where our direct model typically reside more frequently and severely than lower tier cities. These outbreaks have resulted in an increase enclosure for location partners within the regions of impact. As a result, the number of POIs under the direct model decreased to 53% as of the end of third quarter 2022. Our direct model will in the future focus more on high traffic locations or KAs in higher tier cities. We believe the ability for our direct model team to utilize either the direct or network partner synergizes the two models and paves the way for Energy Monster to continue effectively and efficiently increase its network coverage. And by increasing our POI coverage, more customers will be able to find our service when they are in need of a power bank, which ultimately converts into more registered users. This self reinforcing cycle stemming from increased coverage allow us to continuously scale our operation and reach higher levels of benefit from the network effect. Next is our initiatives in improving Energy Monster’s overall efficiency. COVID’s impact in the last few years has demanded us to further improve our industry-leading levels of efficiency to higher level. Even with the general easing of quarantine and lockdown measures in sight, and the gradual recovery to full normalization in progress, we believe efficiency was and always will be a part of our core competence. We continue to reduce the amount of fixed and upfront fees made to location partners during the quarter as we further offload fixed types of expense and better mitigate ourselves from COVID. During third quarter, more than 70% of newly signed POIs were purely revenue sharing, while less than 15% utilized some form of fixed fee. We currently primarily reserve the usage of fixed fees strictly for KAs with established scale due to its lower closure rate and higher traffic. Now, a centerpiece of our efficiency derives from the cost efficiency and stabilities of the hardware we place into the market. With that, we are pleased to announce that we have completed the development is started the mass production of our latest generation of power banks cabinets based on the references of our users. These new six or 12 slots cabinets, future redesigned bodies with a futuristic touch that visually differentiates our cabinet from that of our peers. The internal feature a complete redesign so that it is more easily assembled on the production front. The functionality and capabilities have all been upgraded from previous versions. This features a significant reduction in CapEx per cabinet. Compared to the last generation of cabinet, the newer ones featured 40% plus reduction in CapEx per cabinet. The reduction in cost is significant and it will increase the asset efficiency for both Energy Monster and for our network partners. This reduction is in cost of our cabinet. It's also especially helpful for attracting new network partners and expanding the scale of existing ones given that it reduces the amount of investment that a network partner has to invest, which effectively increases the rate of return of the investment. We are excited to ramp up the production and development of the last generation of cabinet as it will increase Energy Monster's competitiveness and further enhance the experience of the millions of users that rely on our hardware for their everyday charging needs. Our pledge to improving operational efficiency has also reached every corner of our operation. We have left no stone unturned in this regard. During the third quarter, we continue refining the details of our operation in place such as enhancing the logistics and warehousing of our hardware, testing of new marketing campaign to increase user stickiness, upgrading the tools existence that our employees and partners rely on every single day and optimizing the headcounts so that every function performance at an industry-leading level of efficiency. In each of this regard, we continue to elevate the competitive mode surrounding Energy Monster, one block at a time. And by doing so, our pursuit for operational excellence will set us apart from our peers within the industry and unlock higher levels of return for our stakeholders and investors. In the fourth quarter, COVID continued its course and significantly impacted a number of regions. Outbreaks in Beijing resulted in an approximately 70% week-over-week declines in revenue compared to the week before, Guangzhou and Shiyan down about 40%, Tongxin down 80% and Tongshan down about 30%. In recent weeks, we are also seeing a general trend to the easing of quarantine and lockdown measures across the country. We remain cautiously optimistic with this easing trend. We are optimistic in the sense that this will be a first step to the normalization of the offline traffic here in China, but we also remain cautious as the road back to normalization will take a bit of time and where there will be ups and downs during this past to recovery. In recent weeks, after the easing of quarantine and lockdown measures across country, the recovery trend was strong. However, the outbreaks of the virus on the general population in the last week has driven demand down significantly. We expect the impact from the spread of the current virus to continue impacting us during the fourth quarter and into early 2023. We have continued to expand our network coverage and improve our efficiency during the past three years alongside the COVID. While the impact has challenged us operationally and financially, we are confident that Energy Monster will come out of it stronger than ever. Our coverage network is an expansive as ever and our efficiency is evolving to a better lead the changing environment. While we remain cautiously optimistic with the short-term recovery, we are fully confident that the normalization of the traffic in China is inside and we are better than ever to capture the recovery and growth of China's mobile device charging service industry. Thank you very much. I'll now turn the call over to Maria Xin, our Chief Financial Officer for the financial highlights. Thank you, Mars. Now let me walk you through the financial result in greater detail. For the third quarter of 2022, revenues were RMB815 million, representing a 12.4% year-over-year decrease. Revenues from mobile device charging business were down 11.7% to RMB791 million and accounted for 97.1% of our total revenues for the quarter. The decrease was primarily attributable to the impact of COVID-19 during the third quarter of 2022, which resulted in a significant decline in general offline foot traffic in China due to COVID-19 restrictions. Revenues from power bank sales were down 33.9% year-over-year to RMB18.1 million and accounted for 2.2% of our total revenues for the quarter. The decrease was primarily attributable to the impact of COVID-19 during the third quarter of 2022, which resulted in a significant decline in general offline foot traffic in China due to COVID-19 restrictions. Other revenues were down 19% year-over-year to RMB5.8 million and accounting for 0.7% of our total revenues. The decrease was primarily attributable to the decrease in user traffic as a result of the impact of COVID-19 during the third quarter of 2022. Cost of revenues were down 10.2% year-over-year to RMB125.5 million for the third quarter of 2022. The decrease of cost of revenues was primarily due to the decrease in maintenance costs and cost of power banks sold, which was partially offset by the increase in logistics costs for the delivery of equipment to network partners. Gross profit was down 12.8% year-over-year to RMB689.4 million for the third quarter of 2022. The decrease was primarily due to the decrease in revenues from mobile device charging business. Operating expenses for the third quarter of 2022 was RMB786.4 million down 9.9% year-over-year, excluding share-based compensation. Non-GAAP operating expenses were RMB779.3 million representing a year-over-year decrease of 10%. Research and development expenses for the third quarter of 2022 were RMB24.3 million, down 16.7% year-over-year. The decrease was primarily due to the decrease in personnel-related expenses. Sales and marketing expenses for the third quarter of 2022 were RMB752.5 million, down 7.5% year-over-year. The decrease was primarily due to the decrease in entry fees and incentive fees paid to location partners and personnel-related expenses, which was partially offset by the increase in incentive fees paid to network partners. General and administrative expenses were RMB29.4 million in the third quarter of 2022, down 7.9% year-over-year. The decrease was primarily due to the decrease in personnel-related expenses, which was partially offset by the increase in share-based compensation expenses. Loss from operations was RMB97 million and operating margin for the third quarter of 2022 was negative [11.9%] compared to negative 8.8% in the same period last year. Net loss was RMB95.8 million in the third quarter of 2022. Net margin for the third quarter of 2022 was negative 11.7%. Non-GAAP net loss, which excludes share-based compensation expenses was RMB88.6 million in the third quarter of 2022 compared to non-GAAP net loss of RMB73 million in the same period the last year. As of September 30, 2022, the company had cash and cash equivalents, restricted cash and short-term investments of RMB3.1 billion. Cash flow generated from the operations for the third quarter of 2022 was RMB268.6 million. Capital expenditures for the third quarter of this year were RMB111.2 million. Energy Monster currently expects to generate RMB550 million to RMB570 million of revenues for the fourth quarter of 2022. Please note that the forecast reflects Energy Monster’s current and preliminary view on the industry and its operations, which is subject to change. We are now approaching the end of the conference call. Thank you for joining us today. Please don't hesitate to contact us if you have any further questions. Thank you for your continued support and we look forward to speaking with you in the coming months. Thank you.
EarningCall_1498
At this time, I'd like to turn the call over to Vice President of Investor Relations, Ms. Jennifer Driscoll. Please go ahead, ma'am. Good morning everyone and welcome to ExxonMobil fourth quarter 2022 earnings call. Thanks for joining us today. Here with me are Darren Woods, Chairman and Chief Executive Officer; and Kathy Mikells, Senior Vice President and Chief Financial Officer. Our presentation and prerecorded remarks are available on the Investor Relations section of our website. Our fourth quarter earnings news release is posted in the same location and will be joined by the transcript, once it's available. Shortly, Darren will provide brief opening comments and reference a few slides from his presentation. That will analysts more time to ask questions before we conclude at about 8:30 A.M. Central Time. During the presentation, we'll make forward-looking comments, so we encourage you to read our cautionary statement on slide two. Additional information on the risks and uncertainties that apply to these comments is listed in our most recent Form 10-Ks and 10-Qs. Please note that we also provided supplemental information at the end of our earnings slides, which are posted on the website. Also, as a reminder, we posted our Advancing Climate Solutions report, Sustainability Report, and Energy Outlook online in mid-December. We reference them in today’s presentation, and you can find them on our website under the Sustainability tab. Lastly, in the past we’ve held an annual Investor Day in March. We won’t be hosting an Investor Day in 2023. Last December, we laid out comprehensive plans for 2023 through 2027 as part of our Corporate Plan Update and the company is already executing on these plans. We’ve been enjoying the higher level of investor engagement that we’ve been having. We’ll continue to seek your feedback, to host events that give you access to our leaders and insights on parts of the business that interest you, and to share with you information about the company and our plans on more of a real-time basis. Thanks Jennifer. Good morning and thanks for joining us today. Before covering our 2022 results, I want to start by recognizing our people. Their hard work and commitment, not only to the company, but to meeting the critical needs of society, are what drove the strong results we reported this morning. Their work is not easy, whether it’s achieving industry-leading safety, driving record levels of environmental performance, increasing production, offsetting run-away inflation, effectively responding to expropriations, or quickly recovering from winter storms, to name just a few of the challenges, our people delivered while, I’ll add, continuing to manage significant, ongoing organizational changes. As I cover our results, I think you’ll see why we, and the entire management team are so proud of their efforts. Of course, our results clearly benefited from a favorable market but, to take full advantage of the undersupplied market, our work began years ago, well before the pandemic when we chose to invest counter-cyclically. We leaned in when others leaned out, bucking conventional wisdom. We continued with these investments through the pandemic and into today. This year, our improved asset portfolio, organizational changes, and strong operating performance came together to deliver industry-leading results; industry-leading earnings, cash flows, return on capital employed, and total shareholder returns. Excluding asset sales, we had our best cash flow performance since the merger. And, despite lower revenues, we delivered higher profits than 2012, our previous record year with a 400-basis point improvement in profit margin, reflecting upgrades to our product mix, structural cost reductions, and disciplined expense management. 2022 was also a year of strong progress across our five strategic priorities. Importantly, we’ve continued to strengthen our industry-leading portfolio and increased production from high-return, advantaged assets in Guyana and the Permian at a time when the world needed it most. We implemented a series of organizational changes to further leverage our scale and integration, improve effectiveness, and better serve our customers. We combined our downstream and chemical companies to form Product Solutions, the world’s largest fuels, chemicals, and lubricants business. This new integrated business is focused on developing high value products, improving portfolio value, and leading in sustainability. We’re also now supporting our businesses with corporate-wide organizations including projects, technology, engineering, operations, safety, and sustainability. We see further opportunities in supply chain, procurement, and finance. We continued to expand our Low Carbon Solutions business, recently signing the first-of-its kind customer contract to capture and permanently store up to 2 million metric tons per year of CO2. This agreement, in a hard-to-decarbonize sector, highlights how ExxonMobil can leverage our advantages to help others reduce their emissions and build an attractive business with strong returns and significant opportunities for growth. The recent passage of the US Inflation Reduction Act, which incentivizes both hydrogen and carbon capture and storage, further reinforces this. To that end, in December, we shared our plans to invest approximately $17 billion in lower-emission opportunities from 2022 through 2027, up from $15 billion in our prior plan. We also made significant progress reducing greenhouse gas emissions in our existing operations and remain on track with our 2030 emissions reduction plans, including net-zero Scope 1 and 2 emissions for our unconventional operations in the Permian Basin by 2030. In addition to investing in industry advantaged projects, we took advantage of the strong markets to further high grade our asset portfolio with approximately $5 billion in divestments of non-core assets. CapEx was in line with our guidance. To further increase transparency, in 2022, we introduced three new reports; The Lobbying Report, which provides additional disclosure of our lobbying activities and expenditures; The Climate Lobbying Report, which provides details on our US activities at the federal and state level; and our Investing in People supplement, an addition to our updated Sustainability Report. Lastly, as I mentioned, the hard work of our people underpinned our success this past year, as it has done for decades. We build on this advantage every year by attracting and developing the best talent. This past year, we were once again recognized as top in industry for most attractive employer among US engineering students, an honor we’ve received 10 years in a row. Our 2022 financial results, which led the industry, further confirmed the strength of the strategy we developed five years ago. We grew earnings to nearly $56 billion -- $59 billion excluding identified items; significantly outpacing peers. We delivered an industry-leading total shareholder return of 87% and a return on capital employed of 25%, our highest one-year ROCE since 2012. Cash flow from operating activities was nearly $77 billion, also leading the industry. This enabled us to reduce net debt to 5%, fortifying the balance sheet and positioning us to continue our strategy of counter cyclically investing. Our continued focus on leveraging scale and integration drove further efficiencies with nearly $6.9 billion in structural cost savings versus 2019, up from $5.3 billion at the end of 2021. We remain on plan to meet our target of $9 billion in structural cost reductions by the end of 2023. Consistent with our capital-allocation strategy, we continue to share our success with shareholders through a reliable and growing dividend. In 2022, we boosted the quarterly dividend by more than 3% and marked the 40th consecutive annual increase. Additionally, we increased our share repurchase program twice during the year. In total, we returned $30 billion to shareholders in 2022, including about $15 billion in dividends, which also led peers. These actions reflect the confidence we have in our strategy, the performance we’ve seen across our businesses, and the strength of our company’s future. We’re proud of our people and their work to meet the evolving needs of society. As we advance our strategy and the and equation, we’re committed to sharing their progress. Consistent with this, we continue to enhance our disclosures and increase transparency. In December, we updated several important online publications. Our latest Sustainability Report describes the 14 focus areas where we believe our company can have the most impact. The Advancing Climate Solutions 2023 Progress Report outlines our approach to help reduce greenhouse gas emissions in support of a net-zero future. It includes updated resiliency modeling under the IEA Net Zero Emissions by 2050 Scenario, including the addition of carbon and pricing assumptions, and an audit statement from Wood Mackenzie. In addition, it includes a discussion on the value of a life-cycle approach to measuring company specific emissions vs. Scope 3 targets. We believe a life-cycle approach for companies is more aligned with the principles of ESG, better reflects a company’s efforts to reduce society’s emissions, and avoids the negative consequences of a company-specific Scope 3 target. The update also contains more information on how we’re driving reductions in methane emissions. And finally, it includes a look at the role of plastics in the energy transition, and how we’re expanding our capacity for advanced recycling to help address the issue of plastic waste. Separately, we’ve updated our outlook for energy, which is our latest view of energy supply and demand through 2050. It forms the basis for our business planning. In addition to assessing trends in economic development, technology advances, and consumer behavior, our outlook seeks to identify potential impacts of climate-related government policies, which often target specific sectors. We encourage you to read these publications to gain a better understanding of how we’re working to be a leader in the energy transition. They’re available on our website under the Sustainability tab. Our plan for 2023 remains anchored in our existing strategy and builds on our continuing success. I’ll wrap up by highlighting a few key areas. Critically, we’ll continue our efforts to lead the industry in safety, operating, and financial performance. We’ll continue to profitably grow the business through advantaged investments to meet the world’s evolving needs and reduce emissions. We’ll further leverage our new organization to fully realize our advantages in scale and integration and improve competitiveness. We expect to deliver another $2 billion in structural cost reductions, meeting our target of $9 billion in savings versus 2019. We’ll look to capture additional organizational synergies by consolidating our supply chain activities and centralizing a majority of our finance and procurement operations. This will help us take better advantage of our scale and greatly improve our customer, vendor, and employee experience. We anticipate 2023 capital and exploration expenses of $23 billion to $25 billion. This includes investments in the next development in Guyana, and increased spending in US unconventional assets. It also includes advancing our China chemical complex and numerous emission reduction opportunities. We’ll advance our work to reduce greenhouse gas emissions intensity in our operated assets and help customers reduce theirs focusing on hard to decarbonize sectors. We’ll continue to progress our blue hydrogen project in Baytown, that consists of a billion cubic foot per day blue hydrogen plant, the world’s largest, and a CCS project with potential to store up to 10 million metric tons of CO2 per year. We’ll also leverage our recent success in Louisiana to grow the customer base for our Low Carbon Solutions business. As the energy system evolves, our focus on the fundamentals and investments in an integrated but diversified portfolio of advantaged businesses will play a crucial role in capturing value and outperforming competition irrespective of the pace or path of the transition. As you’ve seen, we remain committed to our capital allocation priorities: investing in advantaged projects, maintaining a strong balance sheet to manage across the commodity cycles, and sharing our success through shareholder distributions. We’ve demonstrated our commitment to a reliable and growing dividend and further sharing our success through the share repurchase program with up to $35 billion in cumulative repurchases in 2023 and 2024. 2022 demonstrated the importance of the and equation and the strength of our strategy. We feel good about the progress we’ve made and even better about the opportunities ahead. Hi there. Thanks for taking my questions. Two things. First on your comment Darren on runaway inflation. Obviously, the Permian gets a lot the headlines there. I was wondering if you can talk a little bit about the offshore environment, ExxonMobil is one of the most active in the space there. So, I just want to get a sense of what you're seeing inflation in offshore? And then second question is on CapEx and I probably shouldn't do this. But if I take the 4Q numbers and annualize them, it would be above the 2023 guide, obviously I have to adjust for a little bit seasonality there. But I would have thought you'd be adding growth CapEx 2023 versus 2022, plus you have the inflationary pressures as you mentioned. How much contingency is there in the 2023 CapEx guidance? And what are the risks there, the upside or downside? Thank you. Yes, good morning Biraj. Let me start with your last question and then move to the first. With respect to CapEx, if you look at the range we've given, I think we've indicated in the comments and I just -- the comments I just made that we'll be at the upper end of that range, which is consistent with a slight increase given the work that we're doing. But I would reiterate that the broader range that we've given over the years continues to fit well with our plans and is consistent with the pacing that we established when we came out of the pandemic. As I mentioned before, we had worked with our contractors to lay out a plan for how we continue to progress those investments. And I would tell you today with our projects organization feel really good about the progress we're making, the efficiencies that we're gaining with our CapEx. If you look at the pause that we had to take due to the pandemic, we basically offset any of those costs to maintain the same level of productivity of our spend going forwards. So, something real proud of the projects organization is doing. So, I would expect to continue to stay within that range. And if that changes, obviously, in the years to come, we'll update you as our plans develop and make sure you all stay aware of that. With respect to the inflation, I would say, from an operating expense standpoint, one point I'd make is if you look at what the organization did year-on-year, essentially, with all the synergies that we are capturing, some of the scale advantages and purchasing power we had, essentially, the businesses collectively came in on plants. We're able to offset the inflation that we were seeing from an expense standpoint, which was obviously no easy task. I think on the -- if you look at the different projects around the world, it really is a function of when we chose to engage the contractors and engage the equipment that we're using. I mean, if you look at the Permian, it's the short cycle and where there's a lot of activity. And so like other parts of our business, supply and demand gets tight and puts pressure on pricing, there's less of that supply/demand pressure in other parts of the business and so not seeing the same kind of pressure that we're seeing in the Permian, that tends to be the one area that's really, really hot. But I think in all those areas, we're using the size of the business that we have and the long-term plans that we have and long-term commitments that we can make with our contracting partners to make sure that we're keeping those in check and that our partners are playing the long game here with us. So, I think we've done a pretty good job of keeping capital productivity pretty high, feel pretty good about that. Kathy, anything you want to add? Just the other thing I would add is I'd really caution you about taking the fourth quarter CapEx and exploration expense and kind of annualizing it because we tend to run a bit higher in the fourth quarter and the expenses and kind of prorated over the years. Overall, 2022 came in right about where we expected it. And when we talked about our Corporate Plan in December, we said we expect it to be at about $23 billion to $25 billion in 2023. And that we expected to see a little bit of an increase year-over-year, in part because Payara has been pulled forward, so we have a little more spending there. China One is starting to spool up and obviously, our emission plans are also spooling up. So, right now I'd say we're very consistent with our expectations and the guidance that we've given you. Good morning Kathy, good morning Darren. Questions on the downstream which was a nice positive in 2022. And how do you think the EU embargo on Russian product imports on February 5th will impact your refining margins? And I guess what we're thinking is that there's a number of moving pieces between your refining footprint, particularly in the Gulf Coast and Europe and then there's potential tailwinds for diesel margins as Russian exports dissipate. But there's also probably need to take into account the likely incremental tightness in [BTO] (ph) supplies? Thank you. Yes, I'll take that Jeanine. I think -- start with just the market in general and I think the driver behind the refining margins that we've seen here of late is driven by the pandemic impacts of shutting down capacity and then not having that capacity available as demand has recovered. So, the world remains pretty tight and it will stay I think tight, while we wait for additional refinery expansions to come online, primarily out in Asia and the Middle East. I think the Russia impact and the ban on products going into Europe could potentially have some short-term implications. At the end of the day that -- those products are going to be needed. So, it really is around logistics, I'll call it, disoptimization to where the market is pretty efficient and we've got the most efficient supply chains and logistics systems lined out. We're going to disrupt those and I think it's a question of how does that disruption manifest itself in the market and what kind of disconnects and discontinuities do you see in the short-term? And then ultimately, we'll read that -- the system will stabilize, reoptimize and I expect higher costs just because of your moving to a less optimum logistics approach, but more stable. I don't know -- that's -- that -- I see how that’s going to play out. So, I don't think there'll be a long-term impact, it'll be a short-term one and then there's just a question how long it takes for the systems to rebalance. I think more fundamental to refining is the shortness and with the economies picking up and with China coming out of its COVID lockdown and the economic growth there and then the view that you take on the economic impacts and how severe recessions are here this year, that's probably going to play a much bigger role. If demand picks up, economies continue to grow, we're going to see that tightness manifests itself and continued higher refining margins, which I think will mean a fairly high margins this year and potentially going into 2024 as well. Yes. Thank you, Darren and Kathy. I wanted to spend some time on the Permian outlook for 2023, you made some comments in the prepared remarks about getting to over 600,000 barrels a day. So, I guess that's about 10% growth as we think about 2023. But just your thoughts on volumes and then ultimately, where should we think about plateau? Yes, thanks, Neil. I would take you back to 2018 when we were talking about our strategy in the Permian and we've said at that time, our plan was to grow to 1 million barrels a day of production by 2025. When the pandemic hit, we basically said, there's going to be a delay in a lot of our plans and pushed out those objectives by about two years. So, moving from 2025 to 2027. If you'll look at my comments and the plans, we're now forecasting that our Permian production will reach about 1 million barrels a day by 2027. So, very much in line, going all the way back to 2018. And then the comments that we made around the pandemic and the delay that I was introducing. So, I think that's the context to think about what we're doing in the Permian and that development. If you look at 2021, we added about 90,000 barrels a day of production. 2022, very similar number, 90,000 barrels a day. And that in part was what I'd call, the organic development and drilling into production as well as clearing our DUCs inventory. So, as we were in the pandemic, obviously, not a lot of incentive to bring production on and so we concentrated our spend on drilling. And then as we got into higher-priced environments, concentrated on clearing that inventory and bringing those wells to production, and so we were bringing our DUC inventory down. As we go into next year, we're going to rebuild that inventory, get to an optimum level that we can then use and maintain as we go through the next several years. So, that's kind of a strategy of how we're working out. If you think about, ultimately getting to 1 million barrels a day by 2027, that's roughly at 13% compounded annual growth rate. That's going to -- that's not going to be steady every year, that'll kind of fluctuate, call it, plus or minus 5%. That's kind of order of magnitude how we'll see that playing out. And any one year's production will be a function of the development plans we have and how those development plans manifest themselves in that specific timeframe. But I think bottom-line is we're basically on plan moving at the pace that we anticipated. And I'm hopeful that as we continue to focus on the technology developments and continuing to improve efficiency, we'll see either that production bottom-line with more effectively at lower cost, or in fact, more productivity and higher production. But that's a function of the ongoing work we've got to bring our technology and operational capabilities to bear in the Permian continue to improve what we're doing there. So, I wanted to ask about the Chemicals business and if we look at the margin chart that you have in the slide deck, it's the one part of the portfolio where margins are still below the 10-year range. I was wondering if you could talk a little bit about the trends that you're seeing there as you move into early 2023 with China reopening and that potentially being a positive driver for margins. And then also just talk through some of the discrete growth projects we got coming on over the next few years to drive that that earnings growth you talked about at the Investor Day last year, I think Baytown, you noted later this year and get the China Chemicals Complex still a few years out, but some of the growth projects and the progress there as well? Yes, sure. I think maybe just take both sides of the equation with Chemicals. I'll start with the demand side of the equation, which you referenced and you're right. I think one of the things we saw last year was with the China lockdowns and the lack of growth in China, which is a big, as you know, chemical market that that had an impact on the demand side of the equation. My expectation as we move into this year and the China economy continues to open up, we'll see that demand pick back up again. And then again, a function of whether how deep and how widespread the recessions are around the world, that's going to have an impact. If current conventions and thinking holds and recessions are milder than people anticipated, I think that'll see a benefit in the chemical on the demand side as well. From a supply side, which is a big part of what's suppressing margins today, as we came out -- went into the pandemic, there were a lot of chemical projects that got put on hold and deferred investments. And you're now seeing as we came out of the pandemic and you look at margins in 2021, 2022, very strong chemical margins, we saw those investments get leaned into and a lot of that capacity coming online. So, we've got this a large capacity additions coming on at the same time where we've had some demand slowdown. So, I think what we're seeing play out here is that what I would say is the typical supply/demand swings in that commodity cycle exacerbated somewhat by the effects of the pandemic, still kind of playing itself out, but not inconsistent with what we had anticipated coming out of the pandemic. And so it'll be -- it'll take a little time for that demand to pick up and fill that capacity, but it will get back on the growth trajectory, markets will get tight again. So, that's how we're thinking about the Chemical business. With respect to our projects, feel really good about -- we had to pause those, as you know coming out of the pandemic where we had to make some tough choices about how we spend our capital. We'd never done that before in terms of stopping some projects in midstream. But I again, I'll tell you the organization did a great job of putting those on pause, preserving where we're at, continuing to work with contractors to drive efficiency, and now we're bringing those back on basically in line with the plans that we've laid out in the pandemic. We just brought on the polypropylene unit in Baton Rouge. We've got our Baytown Vistamaxx, and LAO projects, which we anticipate coming on here middle of this year, and then China One is making really good progress and expect that to come on in 2025. So, I think all those investments we feel really good about and are on the path that we had anticipated. I don't know what show whether you -- or Kathy, which one of you two would like to take this, but I want to ask you about your treatment of the European windfall taxes. I'm understanding as you are, I guess suing to try and get some resolution there and treating these as non-recurring. So, can you can you walk us through your rationale versus how your peers are thinking about this? And any cash impacts that you had to incur in the current quarter I guess, would be my clarification question? But thank you for taking my question. Sure. So, I'll first I'll first just talk about the financial impacts. In the current quarter, we wouldn't have had material impacts. Obviously, there were some countries in Europe that had passed incremental taxes earlier this year. So, I'll point to Italy and the UK, as an example. And so we would have been accruing those appropriately. You would have seen as part of our identified items that we booked $1.8 billion associated with 2022. Overall, increased additional European taxes. Now, in terms of the cash impact that doesn't really hit in 2022, we just took the we took the overall accrual and those payments will end up occurring both in 2023 and in 2024. It just depends on the individual countries. But if I take an overall step back and say we looked at what happened in the EU and said, it's not legal and it's the opposite of what is needed, right. So, what's needed right now is more supply and instead, what's been put in place is a penalty on the broad energy sector. So, I'll contrast that with what's happened more recently in the United States with the Inflation Reduction Act, right. There you see policy that's put out to incent industry, both to accelerate technology and decelerate investment, that's greatly needed, especially in areas where the industries in terms of lowering emissions are still pretty nascent, things like hydrogen and CCS, and you're already seeing investment start to flow into those industries. And I would just add, Doug, I think, obviously, we're -- we've been engaged with governments throughout Europe. And I do think there is a sensitivity to the impact on future investments and industries' appetite to continue to invest in what is a challenging market environment in the first place with respect to Europe, becoming more uncertain and less stable. So, I think there was some concern going into this and my suspicion will be many in industry, this will be yet another reason to pull back on their investments in Europe. And I'm not sure you're going to then see that begin to propagate around the world just because of the negative impact it has on an industry that requires stable policy and some certainty when you're making the size of investments that the industry makes over the time horizon that we make them in. So, my sense is that there will be a lot of unintended negative consequences that come from this and as that manifest itself, a lot less appetite for doing this. Thanks very much Darren and Kathy. Darren could you just make some sort of high-level comments about the competitive landscape you see across the business? I know this is sort of a broad question, but upstream Energy Products, Low Carbon Solutions, how do you see competitors' behavior [ph]? Sure, yes, this is obviously a real important focus area for us. And I may just maybe start with a broad strategy and philosophy that you've seen us executing here over the last five years. And as I mentioned on CNBC this morning, I think we see that paying off with respect to the profit margins and the improvements that we're seeing in the profit margins. If we look at 2012, when we had extremely -- our last -- higher revenues than we've got today, we made more money this year with less revenues and that's really a function of the improvement in net profit margin, where we went from about 10% net profit margin in 2012 to 14% in 2022. So, I think a reflection of the work that we've been doing to better position ourselves competitively. If I go down each of the sectors that we're in, I'll start with the upstream where our emphasis has really been making sure that our -- projects that we're pursuing are advantage versus industry and very importantly, are on the left-hand side of the cost of supply curve. So, our strategy there is we can't call the cycles, we can't predict where the markets will go and over what timeframe. But we can control the cost of the barrels that we're bringing on and making sure that irrespective of the environment that we find ourselves in, that we are competitively positioned, versus our competition, that and that our barrels are lower cost. And that's been the strategy and then for the portfolio, where we don't see some of those advantages is to exit those businesses in the hybrid portfolio. That's what we've been doing. I think you're seeing the benefits of that. We've also been very focused on kind of leaning in when others lean out to use the language I used in the press release and that that I think, is paying off as well. And I think resource owners around the world recognize our commitment to that industry and our capabilities with respect to effectively producing barrels. So, I think that's what we're doing there, I think we're very well-positioned. We got a really good portfolio, I think, competitive advantage portfolio. And not only in the cost of supply, but in the quantity and the quality of the projects that we've got there. In the Chemical business, it's really around focused on performance project -- products and making sure that we're leveraging our technology to develop products that have a high value to customers and therefore a higher margin. We build world-scale facilities, start them out on commodity grades, and then quickly upgrade those and fill -- transition to performance products. That strategy continues to play out well. We're continuing to see a lot of poll on our performance products and so that's our strategy there and we continue to invest in that high-end high-value product slate in the Chemical business. In refining, it's really around evolving the yield and the products that we make in our plants. I think contrary to maybe some of the conventional wisdom out there, we actually think the refineries that we're investing in position as well for again, a very uncertain future continuing to make the products that society meets needs today and doing that across a very diversified slate of products. So, think chemicals, fuels products, and lubricants. And then at the same time investing to produce low emissions fuels to address the low carbon demand. And as that piece of the market picks up, we've got a really good competitively advantaged base to shift that production. And you see us doing that the Strathcona project is one example. But we have many, many other concepts in mind to transition, our refinery production in line with that demand evolution. And it's really just a function of pacing. And again, I think that advantages versus the rest of competition, big refining footprint that's going to be needed for these heavy advantaged in making low emissions fuel. So, I think we're well-positioned there. Our Chemical business is well-positioned with the technology and the performance products that were making. So, think we've got a leg up in that space. And then finally low carbon solutions, there's a lot of activity in this space, a lot of interest, particularly with the IRA here in the US. But more generally, around the world, I think, a real focus on low carbon opportunities. I think we're very well-positioned there. This is not a game for startups. This is -- these are large world-scale projects that require the kind of project expertise that we have require the kind of size and balance sheet capacity that we have, requires the technology and operating experience that we have. So, there's a lot of, I'd say, skills and capabilities needed in this market that lend themselves and are consistent with our capabilities and advantages. So, I think it'll take a while for that to shake out, but I am convinced that we are very well competitively positioned in the low carbon solutions business. And if you think about security of supply and counting on your partner to say sequester carbon for 100 plus years, I think you're going to want somebody who's been around for a while and knows how to do that. I think we're the company to do that. If you want somebody who's going to guarantee that when they say they're going to have the barrels available to you, they're there. I think people will look to ExxonMobil to deliver on that. I feel pretty good about our position as well. Thanks. Couple for Kathy, if I may. One is wondered if you could just address the balance sheet and how we're thinking about the differences in the cycle. So, obviously, significant deleveraging and at 5% net debt to cap, I know that's not your target, but it is notable. So, just wondering if you could address at what point do you start to think of the balance sheet as a bit of a drag and also your willingness to kind of continue to delever here acknowledging that there was a long time in the corporation's history where the balance sheet was effectively unlevered? Thank you. So, I would start by saying we view our balance sheet very much as a competitive advantage, right and we know that during the upper part of the cycle, we've got to build a fortress balance sheet, to make sure we have all the firepower we need, and all the flexibility we need to then manage the downturn, which will inevitably come. So, that's how we think about the balance sheet. I think we've made terrific progress. I mean, if you look overall, this year, we paid down about $7 billion of debt, you already mentioned that our net debt to cap is about 5%. We obviously also learned a number of lessons during the pandemic and we have said, we have a willingness to carry a higher cash balance. Our cash balance is around $30 billion right now. So, I'd say overall, at any given point in time, our cash balance is ultimately going to depend on how the market environment ensues. But we know having a really strong balance sheet is a competitive advantage for us. We've been very clear about our capital allocation priorities and at the very top of that priority list is making sure we're consistently investing in advantaged projects, right. We're in a quite good position in terms of having a very rich portfolio of advantage projects, which we're bringing forward. And I think we've taken a very balanced approach and ultimately how we're sharing our rewards with shareholders in 2022, we ended up distributing about $15 billion in dividends and $15 billion in a share repurchase program. So, ensuring that we just have sustainable growing competitive dividends and efficiently returning cash to shareholders. So, that's how we think about it. And we are at the part of the cycle where you would expect us to see a very strong balance sheet, and we're very focused on ensuring that that's indeed what we have. I'll ask about M&A actually, because you're describing a number of advantages that are that are very unique to ExxonMobil, not just at a corporate level, but even in individual asset classes, for example, that you might be in the early stages of efficiency and productivity gains in the Permian, which is really different than a lot of other operators are saying. So, it seems like a opportunity to consolidate and create a lot of value, but at the same time, there's other countervailing forces against that. So, maybe at this point, it would be it'd be great to just hear your thoughts on the overall M&A landscape and what kind of opportunities you see? And then also in the context of Kathy's comments on the balance sheet, which is obviously set up very well right now. Thanks. Yes, sure. Thanks Sam, I'll touch on that and maybe -- see if Kathy has got anything to add. I think the point that you make is exactly the right one, which is looking at where we can take advantage of our capabilities and skills to bring additional value to acquisition targets. And that's really where we put our focus is where can we leverage what we what we're good at and bring value above and beyond what potential acquisition would be able to do without us. That's the focus area. And I think we are in the area that you talked about, we do think with time, the work we've been doing in the Permian will provide a value opportunity that we can leverage when we win the markets, right. And I think expectations start to align around values from a buyer standpoint, as well as a seller standpoint. And so there's an element of that where it's difficult to go in and buy at the top of a commodity cycle. You tend to want to -- at least I want to focus in on when you when you see more, I'd say longer term price cycles being priced into assets, that'll be one of the functions or one of the things that you've got to consider in this space. But it really is we continue to look for where we see the opportunity of bringing value for undeveloped resources in the Permian. I think in a Low Carbon Solutions space, it's a very early business, there aren't a whole lot of opportunities there in that space, but with time that could develop and, obviously, it's challenged in the Chemical space with respect to the technology that we bring to bear on existing assets, but it's something that we continue to look at. Kathy anything to add there? The only other thing I would add is ultimately, we're focused on continuing to high-grade our portfolio overall. And you would have seen in the past year, in what's been a more buoyant market environment, you know that we've made a number of divestments where others saw more value in those assets than we saw. So, we're always looking at both sides of this equation. And depending on the market and what's available, and again, how we think about synergies, how we think about retention value, we'll look to transact, but only when we think it's going to earn good return for our shareholders. Morning, thanks for taking my questions. The first one is for Kathy, just on a couple of items that I think impacted 4Q earnings. You had highlighted on the last earnings call that downstream trading benefits were particularly strong in 3Q and I was wondering if that continued into the fourth quarter? And you also highlighted in the 8-K for 4Q earnings that inventory impacts would be a headwind and that was hoping if you could quantify that as well? Thanks. Yes. And so we obviously in the third quarter quantified that we had a number of favorable timing impacts that we didn't necessarily think we're going to repeat. So, what when you think about Energy Products performance in this quarter, you should think about the absence of some of those positives that we had overall last quarter, right. So, if I look at that just on a quarterly basis, overall, we had from third quarter to fourth quarter in Energy Products, unsettled derivatives of about $1 billion as a headwind, that's really the absence of largely a positive that we would have had in the third quarter. And then again, in the third quarter, we talked about the fact that we have a program associated with achieving ratable pricing in our refinery runs and that had given us, again, I'll call it benefit in the third quarter. And in the fourth quarter, price timing differences were negative to the tune of about $400 million. I think the most important thing, though, is to actually take a step back and look at the full year results because what we've told you during the year is, look, we're going to have these price timing impacts, especially mark-to-market on open derivative, positions are going to move around quarter-to-quarter and during the year. But if you looked at Energy Products on a full year basis, our unsettled derivatives were basically neutral, right? And price timing impacts, and again, I would have referred to this coming largely out of our priced inventory program, were about a $400 million negative when we look at just 2021 to 2022. So, like we have said all along, the quarter-to-quarter impact may be a little bit more volatile. But when you look at the full year results, it tends to settle itself out. If you looked at overall year-end inventory impacts, they would have had the biggest impact in our Upstream business. And as part of the inventory adjustments we made, we had to look at gas inventories overall in Europe with prices declining pretty significantly. If you looked at our overall year-end adjustments to inventory outside of that, I would have called them kind of neutral to modestly favorable with the largest favorability incurring in Energy Products. Got it. Thanks. And then my follow-up is just on downstream maintenance, which it seems like refining maintenance will be particularly high in 1Q. I wonder if that's just kind of a bunch of things getting -- just getting aggregated into one quarter, if it's going to be a higher year overall moving through the year, if there's something else going on. Just a little more color on that number and the outlook for the year would be great. Thanks. Yes, I'll take that one. I would just say turnaround timing is really a function of -- and the spend that we have in that area is really a function of the mix and the units that we're bringing in at the different -- into turnarounds around the different refineries and the age of those units. And so I wouldn't take away some structural change or outlook for the year. It's really just a function of which refineries and which units that those refineries are coming into turnaround and the work that we have to do to get those units back on their maintenance schedule. So, that's what's happening there. Hey thanks. Maybe a higher-level question, following up on some of your comments earlier on competitive position. Relative to past cycles, the competitive environment in upstream oil looks far different than many times in the past with both fewer players in the industry and many of your largest peers strategically under-investing in oil. How does it -- how do you think this impacts global supply over time? And how does it impact your -- as you look forward, how does it impact your competitive position within the space? Does it open the door for additional opportunities for you? And in E&P projects, does it -- whether in terms of expiration leasehold, competition or project development or even within the asset transactions in the M&A space, have you seen an impact to-date? And how do you think that evolves in the coming years with the changed competitive landscape? Yes, thanks. I'll take that one, Ryan. It's -- I think you hit on a very good point, which is -- and the point that we've made historically is there has -- we are under-investing as an industry in this space. And in the depletion business, we are not keeping up with that depletion or not offsetting it and covering the growth. You find yourself in tight markets. And I think as the broader public narrative has moved in this space and some of our competitors have stepped back for investment there, that does tighten the amount of capacity that's coming on and the supply that gets brought in on over time. And until you have competitive alternatives, lower emissions, competitive alternatives that address the full set of needs for society, there's going to continue to be a demand for oil and gas and oil products. And so I think you're seeing the potential for continued tight markets. I think we have found, certainly over the last five years, that our continued commitment to strengthening the capabilities that will allow us to bring on competitively sourced oil and gas and do that in an environmentally responsible way, that, that has resonated and is being recognized by resource owners around the world. And so I do think that does give us a bit of an advantage with respect to the opportunity set. And I would say that we continue to work to earn the advantage by developing those resources very effectively, bringing projects on ahead of schedule, under budget and doing things that, frankly, some of our competitors are challenged to do. And so I think it's a very supportive environment that we find ourselves in. The focus that we have in this space, I think, is appreciated and gives us an advantage versus the rest of the competition. And I'll also add that we're doing that while, at the same time, balancing the risk of the transition and investing in the low emission side of the equation. And so we've got this unique position where the same core capabilities that we're using to drive value in our traditional businesses, we're using those and leveraging them to drive value in the Low Carbon Solutions business and keeping a very keen eye on the developments in all those industries and making sure that we adjust our investments in our strategy and our allocation of capital based on the developments that we're seeing in those space. So, we've got optionality and we've got flexibility. And we've got a core set of competencies that lend themselves to every part of that -- of those businesses and across our portfolio. So, I feel really good about that. And I think the folks that were out there or the partners that we're looking to partner with recognize that and value it. So, I think we'll see that manifest itself in the deals that we continue to do and the businesses that we continue to grow. Hey guys. Good morning. Thanks for taking my question. I just wanted to ask on the Beaumont expansion and how the ramp is going there. And in terms of profitability, we've got Midland trading above Cushing now, but that's probably not significant given diesel cracks are very, very strong. So, just wondering on the profitability of that project out of the gate relative to how you've been thinking about it when you sanctioned? Yes, I'll take it. As I said before, if you look at Beaumont, when we -- the concept of that project was developed five-plus years ago. And it really was looking at what I would call the feedstocks and intermediate balances going into that refinery and the options that we had to optimize the logistics piece of the equation and justified that project purely on logistics optimizations and lower-cost transportation to feed that refinery. And that's kind of how we thought about that, so that is robust to wherever you're at within the cycle. If you layer on where we're at today in the commodity cycle and the fact that we are at on the very high end of refining margins, my expectation is that that refining expansion will do much, much better than what we -- the basis on which we appropriate it just because we find the timing of where we find ourselves in that cycle. And that's good news. I mean that's, I think, an important part of the investments that we make to make sure that we're kind of participating in all phases of the cycle. But I think even better news is we're not depending on that to generate a return from that investment. So, even as we move through the commodity cycle and at some point in the future, we find refining margins start to come off, and eventually, we'll find ourselves in the bottom of the refining commodity cycle. That expansion will position our Beaumont refinery very well and will, I think, continue to be incremental to the value of that refinery. So, feel really positive about that. We're making good progress. We mechanically completed that a little ahead of schedule, and we're making good progress on ramping that facility up. Yes, thank you and good morning. Glad you're able to port me in here. Just wanted to follow-up on Guyana. I think there was a lot of expectation at the Investor Day -- well, won't be an Investor Day, but there'd be a potentially big update on Guyana. I know things are going well there from a development standpoint, but I was just hoping you could address anything on the resource side and any update at all from a PSC political side, there's been a little noise out there on that end? Yes, I think the point you made, we're making really good progress. As we've said, we brought Liza 2 in ahead of schedule. We anticipate bringing Payara in ahead of schedule. We brought Liza 2 up very well, brought that online quickly and began producing at above nameplate capacity in the fourth quarter. And so I feel really good about the quality of those projects and the operational ability to bring those up and run them effectively, making good progress there. We've got Yellowtail in for government approval. I expect that to be a bigger FPSO. So, we're making -- I would say we're at or ahead of the schedule and ahead of the expectations that we've talked about historically with Guyana. The resource base, as you know, continues to grow. We continue to make discoveries. We continue to really optimize around those discoveries. And that's a really big part of developing these projects is as we are in parallel to developing projects, continuing the exploration and then continuing to better quantify and qualify that resource base is making sure that our projects are optimized around that. So, there's a balance that we're striking around how best to optimize, and feel good about what we're doing there. And frankly, I think the government feels really good about what we're doing there. Importantly, the development of that resource and the value associated with that is manifesting itself in the country, which is a really important part of the equation here. We always said coming into this that this has to be a win-win-win proposition, needs to be a win for the company, it needs to be a win for the government of Guyana and it needs to be a win for the people of Guyana. And that's what we're seeing there, a lot of jobs, a lot of economic opportunity opening up in Guyana. We've just -- we've been working with the Guyanese government around a project to bring in gas power into the country, lower emissions and more reliable. We've got work going on to help bring up some of the other social services in the country. So, I think people are seeing the progress. And the fact that we're bringing this on sooner and at lower cost, I think, is a benefit to the government. They recognize the values coming faster than originally anticipated. So, it's a -- I think it's a good story of government, I think, and ExxonMobil, got very good relationships, working very constructively. And as I said, it's a win-win-win proposition here and feel good about the progress we're making. I think as the team continues to drill and then quantify and characterize the results of those drills, when it gets to a material improvement, we'll be out talking about that. Thank you, everybody, for your questions today. We will post a transcript of our Q&A session on our investor website by the end of the week. Have a nice day, everyone. And I'll turn it back to the operator to conclude our call.
EarningCall_1499
Good afternoon everyone and welcome to AAR's Fiscal 2023 Second Quarter Earnings Call. We're joined today by John Holmes, President and Chief Executive Officer; and Sean Gillen, Chief Financial Officer. Before we begin, I would like to remind you that the comments made during the call may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from the forward-looking statements. Accordingly, these statements are no guarantee of future performance. These risks and uncertainties are discussed in the company's earnings release and the Risk Factors sections of the company's Form 10-K for the fiscal year ended May 31, 2022 and Form 10-Q for the fiscal quarter ended August 31, 2022. In providing the forward-looking statements, the company assumes no obligation to provide updates to reflect future circumstances or anticipated or unanticipated events. Certain non-GAAP financial information will be discussed on the call today. A reconciliation of these non-GAAP measures to the most comparable GAAP measures is set forth in the company's earnings release. Great. Thank you and good afternoon, everybody. I appreciate you joining us today to discuss our second quarter fiscal year 2023 results. Sales for the quarter were up 8% from $437 million in the prior year quarter to $470 million and adjusted diluted earnings per share from continuing operations were up 30% from $0.53 per share to $0.69 per share. Our sales to commercial customers increased 21% and our sales to government and defense customers decreased 12%. Sequentially, sales to commercial customers increased 6% [ph] and sales to government customers increased 3%. I'm pleased that we continue to see progress in the recovery of our commercial volumes, notwithstanding the fact that global flights are still down approximately 20% from 2019 levels. In particular, in our cards activities, we saw sequential improvement in the demand for both USM and new parts distribution. While this is encouraging, we have been more encouraged by the opportunity for further improvement as the volume in these activities is still down over 20% from our FY '20 levels. On top of this, we expect the full ramp-up of our new distribution agreements and the increased adoption of USM to provide growth opportunities beyond the market recovery. In MRO, we were able to generate sequential growth driven by facility optimization and growth in the non-hanger portions of our MRO operations. Our government sales continue to reflect the prior wind-down of certain programs, including Afghanistan and I'm pleased that we returned to sequential growth this quarter. With respect to margins, we delivered another strong quarter as our operating margin was 7.6% on an adjusted basis, up from 6.1% last year and 6.9% last quarter. This reflects our commitment to cost discipline, a mix shift towards parts which is our highest margin activity and outperformance on certain programs. We do continue to experience labor market tightness but that appears to be stabilizing and the programs that we established years ago to create a proprietary set of labor pipelines continue to serve us well. In addition, we are engaging with our customers regarding price increases for calendar year 2023 in order to address the higher labor costs we are experiencing. As we indicated during last quarter's call, we had compelling opportunities during the quarter to invest in new long-term business and in attractive USM assets. These investments totaled approximately $60 million in the quarter which drove a use of cash and operating activities from continuing operations of $46 million. We also repurchased $28 million of stock in the quarter under our share repurchase program. Even after the investments and the share repurchase, our net leverage was 0.9x EBITDA and we continue to have significant balance sheet strength and flexibility. Among the investments in new business or new long-term business that we announced during the quarter was the expansion of our distribution relationship with Unison. This significant new agreement broadens our long-term distribution of select units and igniter plugs, ignition leads, harnesses and related spare parts to now cover all aftermarket customers worldwide. Also during the quarter, we announced a new multiyear flight hour component support agreement with flydubai which expands our support to include the new addition of flying -- flydubai's growing fleet of 737 MAX aircraft. Finally, we signed a new Airinmar agreement with Philippines-based low-cost carrier, Cebu Pacific to provide a full suite of services covering both aircraft, warranty management and value engineering. Before I turn it over to Sean, I would like to comment on the inclusion in the DoD's FY '23 National Defense Authorization Act of a position stating that the Navy and Air Force will implement processes and procedures for acquiring used serviceable material to support their commercial derivative aircraft and engines. Historically, the U.S. government has acquired mainly new aircraft and new aircraft parts. This legislation institutionalizes the process for the DoD to consider the use of USM as a better value solution whenever it's available and is an initial step in the unlocking of a significant untapped market for our used parts offerings. Over the years, we have found great partners in Congress on a variety of initiatives and I would like to thank them for their work on this important opportunity to drive taxpayer value. Thanks, John. Our sales in the quarter of $469.8 million were up 7.6% or $33.2 million year-over-year. Our commercial sales were up 21%, while our government sales were down 11.7% due to the completion of certain government programs, including our Afghanistan contracts. Sequentially, our commercial sales were up 6.2% and our government sales were up 3.5%. Gross profit margin in the quarter was 18.3% versus 18% in the prior year quarter and adjusted gross profit margin was 18.8% versus 16.7% in the prior year quarter. Gross profit margin in our commercial business was 18.4% and gross profit margin in our government business was 18%. The increased margins in the quarter reflect continued strong performance in our parts supply and MRO activities as well as favorable cost performance on certain commercial and government contracts driving higher contract profitability in the period. SG&A expenses in the quarter were $52.8 million. This figure includes continuing investments in our digital initiatives as well as $1.1 million related to investigation and remediation business. Net interest expense for the quarter was $2 million compared to $0.4 million last year, driven by higher interest rates and borrowings. As John indicated, cash used in operating activities from continuing operations was $45.9 million, driven by investment in new long-term business wins and the acquisition of inventory to support our USM activities. In addition, we bought back approximately 700,000 shares or $28.2 million which is higher than prior quarters as we took advantage of favorable market dynamics in our open window. We have the balance sheet strength to continue to invest in our business as well as to continue to execute on our share repurchase program on which we have $57.6 million of authorization remaining. We ended the quarter with net debt of $149 million and net leverage of only 0.9x. In addition, last week, we extended the maturity of our revolving credit facility for another 5 years and increased the size from $600 million to $620 million which gives us significant liquidity. We appreciate the continued support of our bank group and executing that extension and upsizing. Looking forward, our largest North American airline customers continue to be confident about demand resiliency and expansion. We are also encouraged by recent signs of demand improvement in Europe and early indications are that the easing of lockdown restrictions in China, were flying activity is still down 70% from pre-COVID from 2019 levels is already leading to an increase in flight hours. In addition, we are beginning to see signs that engine green time availability for certain carriers may be dwindling which will lead to increased engine shop visits which are an important source of demand for our USM parts. We've been anticipating this inflection point for some time and we are now seeing early signs that is occurring. With respect to our government business, we expect long-term contract and short-term procurement wins to continue to contribute for the balance of this fiscal year, leading to continued growth. Overall, we expect sequential sales growth in Q3 to be consistent with the increase in Q2 and we expect further growth in Q4. We expect margins in Q3 to be in line with levels we have seen over the last few quarters. In the medium and the longer term, we believe that we are exceptionally well positioned for growth for several reasons. First, commercial market conditions are favorable including strong leisure and business travel demand, the reopening of international markets following the relaxation of travel restrictions and OEM production challenges that are extending the life of the existing fleet; second, our parts volumes although recovering are still well below pre-COVID levels and we have every reason to believe that they will not only fully recover but also grow based on increased acceptance of USM and the maturation of several recently awarded new parts distribution contracts; and third, our government programs offering is consistent with the best value commercial best practices support that the U.S. government is increasingly seeking and the new NDAA language facilitates the government's ability to act on more of our offerings. Further, we are supplementing these growth initiatives with investments in digital efficiency which, along with improved operating leverage and a mix shift towards parts to continue to drive margin expansion. John, wanted to open with maybe a higher level industry question. But there's some discussion at the slower-than-expected OE ramp from Airbus and Boeing will drive an extended aftermarket cycle for the next couple of years. I wanted to ask your thoughts on this, John. Yes, we would agree with that. And we think that's one of the core favorable trends that gives us confidence in the growth we're talking about in as much as the platforms that are bread and butter for us are going to be flying longer than people anticipated originally. And then you talked a little bit about USM. I was going to ask perhaps for a little bit more color on where the USM market is today? And then -- and maybe you could segue that into your comment on the NDAA and talk about your reach into military USM versus commercial where you clearly have a strong track record. Sure. The U.S. market in general, we talked a couple of quarters ago about anticipating an inflection point in the recovery of that business and that was related both towards the demand as well as the supply. The demand out of customers has taken a bit longer than we anticipated at that time to come back. And there have been a number of factors driving that but most recently, what we have seen and heard from our customers is that they were still utilizing a lot of green time on engines. In other words, they had aircraft that were parked, in many cases, due to pilot shortages and then we're moving engines around to defer maintenance. For key customers that we support, that green time is dwindling and those engines and that deferred maintenance is now coming due. And so the engine shops, for example, that we support we are seeing signs of increased demand as they look at their input schedule for 2023. So we believe that inflection point in terms of demand we're at the beginning of that. Coupling that with surplus material availability, it has been a very tight market. We have just recently started to see things come available for certain asset types that we support. And that was one of the reasons we put out the capital this quarter was to move quickly to acquire that material. And we are seeing, even as we look into early next year, more opportunities to put capital to work to acquire materials to support that anticipated increased demand for USM. So that's the commercial market. The government market we've had success here and there in terms of selling used material to the government. In some cases, on a small parts basis but in other cases, in a whole aircraft basis like we did a couple of years ago with C-40s. But we haven't ever had a structural change in the law which is what's reflected in the NDAA language that compels services like the Air Force and the Navy to consider USM. So for commercial derivative aircraft like the C-40 of the PA which are 737,and the C-32 which is the 757, we think this could be the starting point of meaningful opportunities for AAR. How much and how long, I think, is the question but we're really encouraged by the fact that, that language is now part of the NDAA. Okay. And then, Sean, if you're able to, can you parse out the 21% commercial aero growth in the quarter across the sub business lines? Yes. I think 21% really across all commercial activity that say we saw outsized performance in our distribution business which reflects some of the new business wins over the last several years. And then also within our commercial PVH which is a flight hour driven a little bit more international than some of our other commercial activities, we saw improved flight hour activity which drove that top line. But strength across all commercial that highlight those two is driving some of the outperformance. Okay. And then just how do you expect with maybe continued investment in distribution, how should we think about cash flow in the second half of the fiscal year? Yes. I think if you look at our cash performance over the last 8 or 9 quarters, we’re really proud of the cash that we’ve generated. And obviously, that’s reflected by the low leverage ratio on the balance sheet. The inventory positions we had have been a source of cash. But as we look forward, we would expect to be more in investing mode in the back half of this year the way we were in the second quarter. John, I just wanted to start out maybe on the usage of working capital this quarter. Can you parse out maybe how much of that was for maybe to support distribution agreements versus assets on the USM side. And on the USM side, guessing it’s maybe more engines versus other systems. What are you seeing in terms of pricing? Are you seeing a significant uptake in what you’re having to pay to acquire the assets just considering the tight supply? How should we think about that? Yes. As the -- so the first part is the capital breaks down, it was slightly more towards the USM side. If we think about the 2 areas, USM and new parts distribution agreements, we're skewed slightly more towards USM but fairly equal between the two. And then on -- and then on the new parts distribution agreements, I mean those are our initial provisioning inventory buys that go on with these contracts when we take them on. And obviously, we worked down those positions over time as the contracts mature. As it relates to pricing in USM, I wouldn't want to get into that, in particular, for competitive reasons but it remains a tight market and we're able to achieve the right spreads between the prices that we pay for material and the prices at which we sell material. So we're kind of market in, market out as it relates to these USM buys. Okay. That’s helpful. And as we think about moving forward, you’ve obviously been extending some agreements like with Unison. It seems like you’re bringing in some new OEM customers. What’s the landscape like for additional OEM partners as you think about incremental distribution agreements. It sounds like there’s more out there considering your comments regarding sort of cash usage in the second half of the fiscal year? Yes. We see a lot of opportunity in distribution. We see opportunity to expand agreements with our partners like Unison and we're real proud of that expansion. It's a big one for us and that's a 10-year-old relationship and we're still finding more things to do with them. And we have a number of other long-term OEM relationships that are in the same category where there's opportunities to expand as they rethink their approach to aftermarket coming out of COVID. And then there's new areas. The -- we've got an agreement with Leach that we announced that we expanded. That's a new market for us. That's electronics distribution. So we're selling piece parts into production line. So that's a new market for us and Leach is the launch deal there which we've extended and we see more opportunity in that market. There's also opportunities in the BAGA market. Obviously, a lot of interest in BA coming out of COVID that's been a very strong market in general and we think that our way to participate in that market is through distribution. And so that, again, would be a new focus for us but a number of OEMs that we're talking to have interest in leveraging our distribution network. Okay, very helpful. And you've often talked in the past about sort of seeing a step change ideally in aviation margins. As you start to see the recovery in the parts business, specifically, I guess, surplus material being one of the higher margin pieces of the business. How do we -- how should we think about margins in that segment in the second half as you're starting to see this acceleration in some of the agreements here and obviously availability of USM and increasing demand? Yes. I think margins in general, we had a very strong quarter this quarter. I think margins in general in Q3 from the immediate term would be consistent with the last few quarters that we've delivered. And again, you've seen some pretty consistent performance there. That's in the immediate term. Beyond that, to your point, as the mix continues to shift towards parts as we recover and grow in that business and we start to get some efficiencies in MRO as a result of some of these digital initiatives, in particular, that we've been investing in, we would expect continued expansion beyond that kind of 7% level as those things take hold over the medium and the long term. Okay. Helpful. And just one final question. In the past, I know you’ve got a cost reduction effort going on. In the past, I think you had a target of sort of getting SG&A down to 10% or under of sales. And I know it’s not something you’ve talked about recently. But how do you think about the cost opportunities moving forward? Is it on the SG&A line? Is it other parts of the business? Where should we look for you to sort of have more cost opportunity over the next few quarters and into fiscal ‘24? Yes, great. Great question. We see -- so first of all, getting to that 10% or below SG&A as a percent of sales is still a goal. We believe that a more significant contributor towards reaching that goal will be the recovery in the top line. We took a lot of costs out there in COVID as you know, made a lot of structural changes to the business. And our focus right now is just staying disciplined in terms of preserving those changes as we grow. So as top line continues to recover, we expect that percentage to come down. The other thing I would point out is we are making investments, particularly in the digital area that we do expense and so they flow through those lines. Those investments are very much – we’re in the thick of those right now but they’re projects. They’ve got a beginning in the middle of an end. And as we wrap up those projects, we would expect those expenses to come down and the efficiency as a result of those projects to start to kick in. Maybe just on that SG&A, I think you were up about maybe 5% or so, almost $3 million sequentially. Was there anything specifically that drove that in the quarter? Or was that kind of all part of the digital investment and expensing some of those items you were just talking about? It's predominantly that. It's predominantly that. I mean, we have, in certain areas, we've seen people costs go up as well. And so that's contributing to it. And that some of the relief ultimately, we hope to get through some price adjustments to offset that but it's those investments in those projects and then certain labor costs that are flowing through that line. Got it. Got it. And then maybe just back to kind of Rob's first question on kind of the -- just the more broader trends in the aftermarket. Is there any validity to maybe the thought that we could see a low in aftermarket activity when we look at claims coming off warranty? I mean, if we go back to the 2018 period, planes coming off. There's obviously going to be this period where we have fewer new planes coming off the assembly line, maybe those first-time shop visits. I mean, is that something you guys are looking at as you get out into '23 and '24? How that dynamic plays out? I think that's definitely a dynamic to pay attention to. However, from where we sit, the more powerful dynamic is the extension of the current fleet as a result of those production delays. Yes. Okay. Okay, got it. Last one I had, Sean, just the government looks to be trending down. I guess it will be maybe 15%, 17% in terms of revenue for the year. Is that kind of the right expectation? Or are there any new wins or things ramping up that might create a little bit of an inflection here? Yes. I think we saw some modest sequential growth from Q1 to Q2. And as John mentioned in his cost, I think we’d expect to see a little bit of that modest growth continue over the balance of the year as some of the longer-term contracts that are replenishing things that had ended as well as some more short-term procurement activity for the government will show up in the results over the second half. On the green time availability comment, how are you measuring that? Or maybe what metrics are you tracking to give you so much confidence that we’re hitting this critical crossover? It's really driven by the key customers that we support and their shop input schedule as they look over the next 6 to 12 months. So you haven't seen the engine overhauls come through in a way that we expect to see them now based on what we're talking -- or based on what we're hearing from our customers. So shop inputs would be the key metric. Got it. And then just on the labor kind of question, how are airlines looking at their internal labor availability or cost versus the outsourcing option to air? Does it take – excuse me, does the tight labor market help the outsourcing dynamic for you? I think it's a challenge for everybody. So I think it's really a level playing field. So I don't know that it necessarily changes the calculus at the airlines in terms of whether to bring in work or outsource work. I think that's a relatively stable relationship. So our discussions are all positive in terms of the amount of work that they -- would like to continue to outsource to companies like ours. Got it. And then just one last one. As we exit COVID here into change markets, you’re making the digital investments, you’re re-establishing some relationships with fly-to-buy and others. But what do you think the long-term kind of strategic vision or positioning is for Air? It’s been a while since we had an Investor Day. Do you see any changing in that positioning? Or just curious kind of on the longer-term outlook. Well, I think, first of all, we anticipate now that we can all be together again, we do anticipate getting back at a regular cadence with Investor Day this next year. So we're looking forward to that opportunity. But as it relates to the overall strategy, certainly, we want to wait until we have an opportunity to discuss that more fully. But as you can tell, I mean, we remain very focused on building out our parts capability. We're having a lot of success there both on the USM and on the new parts distribution side. Our MRO portfolio is operating at a level of efficiency that we hadn’t experienced prior to COVID, so we want to make sure that we preserve that and in areas where we can expand MRO where we have long-term customer interest and long-term access to labor, we expect to do that and look for ways to grow in that business. You mentioned digital, digital, there’s elements that benefit us internally from efficiency but then also digital offerings like Airinmar and AIRVOLUTION that drive new sources of revenue for us. And then we continue to look at ways to bring areas of IP, whether it’s through PMA parts or DER repairs into the portfolio to drive continued margin improvement. And finally, we remain in a very strong position with the U.S. government. We’ve really built a meaningful portfolio of past performance that allows us to bid on a variety of contracts. We’ve got a very strong pipeline of bids there and work as well as bids that are with the government right now. And so we feel very good position to continue to be successful as a prime contractor there. John, it sounds like you've got a pretty significant set of organic investment opportunities as you think about USM, distribution and other areas and what you just went through. Should we assume that M&A or meaningful M&A is off the table? Or how should we think about that in terms of capital allocation? No, great question. And no, I certainly would not want to suggest that M&A is off the table. Our framework for capital allocation is organic investment first, inorganic investment M&A second and then returning capital to shareholders. And the balance sheet remains very strong. We're still less than 1x levered. So we believe we've got the opportunity to deploy capital in the first area, organic investment but then also keep options open for M&A. And there are a number of companies out there that could be very interesting to us. Some are new, some we've been following for years. And to the extent that we find an opportunity where evaluation and our strategy align, we absolutely would pursue M&A. Okay. And just finally, you did just call out PMA again. You haven’t been talking about PMA as much recently and I know it had been sort of identified as a growth opportunity in the past. It seems like through your distribution agreements and everything else, you were becoming maybe a little bit more OEM aligned with the business strategy. Is PMA something, I think, that’s still seriously in the mix? Or how do we think about that in terms of priorities for you? Yes, I think it's very much in the mix. And it's a big world out there and we do see opportunities on a selective basis where we would not, in any way, be in conflict with our OEM partners to pursue PMA. We have an internal effort underway. It's very small. I was actually visiting the team a couple of weeks ago and there are some really exciting things that they're working on. But it's relative to the total of AAR, it's a small operation. But we do expect to scale it over time. It's just -- it's going to take a while. But the initiatives are around coming up with PMAs that are only available to us for use in our own repairs as well as PMAs that we could offer to third parties. I'm not showing any further questions in the queue. I would now like to turn the call back over to management for closing remarks. Great. Well, we really appreciate everybody’s time and interest and I want to wish everyone a happy holiday and look forward to being back and discussing Q3. Thank you.